Webster Financial 10-K 2007
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 2006.
Commission File Number: 001-31486
Webster Plaza, Waterbury, Connecticut 06702
Registrants telephone number, including area code: (203) 465-4364
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act Not Applicable
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act of 1933. Yes þ No o.
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. Yes o No þ.
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. Yes þ No o.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Exchange Act Rule 12B-2).
Large accelerated filer þ Accelerated filer o Non-accelerated filer o
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12B-2). Yes o No þ.
The aggregate market value of the common stock held by non-affiliates of Webster Financial Corporation was approximately $2.4 billion, based on the closing sale price of Common Stock on the New York Stock Exchange on June 30, 2006, the last trading day of the registrants most recently completed second quarter.
The number of shares of common stock outstanding, as of January 31, 2007: 56,465,108.
Part III: Portions of the Definitive Proxy Statement for the Annual Meeting of Shareholders to be held on April 26, 2007.
WEBSTER FINANCIAL CORPORATION AND SUBSIDIARIES
WEBSTER FINANCIAL CORPORATION
2006 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
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 December 31, 2006 had assets of $17.1 billion and shareholders equity of $1.9 billion. Websters 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, residential and commercial mortgage origination and insurance premium financing on a regional or national basis. Webster Bank provides commercial banking, retail banking, health savings accounts, consumer financing, mortgage banking, trust and investment services through 177 banking offices, 334 ATMs and its Internet website (www.websteronline.com). Websters common stock is traded on the New York Stock Exchange under the symbol WBS.
Websters mission statement is the foundation of our operating principles, stated simply as We Find A Way, to help individuals, families and businesses achieve their financial goals. The Company operates with a local market orientation and with a vision to be New Englands bank. Its operating objectives include developing customer relationships through cross-sale opportunities to fuel internal growth, increasing the products and services currently offered and expanding geographically in contiguous markets through a build and buy strategy.
Webster facilitates cooperation across its business segments through its Sales Council, with focused sales teams, organized by geography or industry specialty, that approach our markets to deliver the totality of Websters capabilities with a unified approach. These teams consist of members from each business segment, meet regularly to share opportunities, and call jointly on customers and prospects. This group works together to develop deep customer relationships through cross sell of products in and across lines of business.
Retail Banking is the largest line of business within the Webster franchise and is dedicated to serving the needs of approximately 400,000 consumer households and approximately 60,000 small business customers in southern New England and eastern New York State. Websters Retail Segment is intent on growing its customer base through the acquisition of new relationships and the retention and expansion of existing customer relationships.
Retail Bankings primary focus is on core deposit growth, which provides a low-cost funding source for the bank in addition to an increasing stream of fee revenues. As of December 31, 2006, retail deposits within the branch footprint totaled $10.2 billion. Websters successful execution of its strategy is evidenced by its #2 ranking in deposit market share in the state of Connecticut. Core deposit growth is driven by a growing base of checking relationships, strong customer retention and successful cross-sell efforts including increasing debit card and on-line banking usage. Revenue growth is achieved by offering a range of deposit products that pay competitive interest rates to meet customer savings and liquidity management needs and deepen customer relationships.
Retail Bankings distribution network provides convenience and easy access to Websters full range of products and services. This multi-channel network is comprised of 177 banking offices and 334 ATMs in Connecticut, Massachusetts, Rhode Island and New York. It also includes a telephone banking center and a full-range of internet banking services. In addition to deposit products, Retail Bankings distribution network delivers a full range of consumer lending products such as home equity loans and mortgages as well as investment products offered through Webster Investment Services, Inc.
Retail Banking includes the Business & Professional Banking division (B&P). B&P is focused on the development and delivery of a full array of credit and deposit-related products targeted to small businesses and professional services firms with annual revenue up to $10 million. B&P markets and sells to these customers through a combination of direct sales (Business Bankers) and branch-delivered efforts. B&P is a significant provider of deposits to Webster. The B&P lending effort is focused on those customers with borrowing needs from $25,000 to $2 million. Webster was recognized in 2006, for the fourth consecutive year, by the Connecticut district of the Small Business Administration as the states leading bank SBA 504 lender.
An important element of Websters Retail growth strategy is its build and buy strategy for franchise expansion. Webster takes a disciplined approach to both de novo branch expansion and franchise acquisition in attractive markets. Six branches were opened during 2006 with new locations added in each of the four states within our footprint. Through the de novo branch expansion program, a total of 25 de novo branches have been opened since 2002, adding a total of $734 million in deposits through December 31, 2006. Websters acquisition of the NewMil franchise in early October boosted Websters presence in western Connecticut by adding 14 additional branch locations and $615 million in retail and B&P deposits.
HSA Bank, a division of Webster Bank, is a national leader in providing health savings accounts. HSA Bank focuses entirely on marketing and servicing health savings accounts (HSAs). HSA Bank serves customers in every state, combining specialized knowledge, convenience and service with competitive account maintenance fees, 24-hour access online and telephone service. HSA deposit balances increased 36.8% to a total of $286.6 million at December 31, 2006 compared to $209.6 million at December 31, 2005.
Websters Consumer Finance division provides a convenient and competitive selection of residential first mortgages, home equity loans and direct installment lending programs through Webster Bank and its wholly-owned subsidiary, Peoples Mortgage Corporation (PMC). Webster Banks loan distribution channels consist of the branch network, loan officers, call center, and third party licensed mortgage brokers. Additionally, loan products may be offered periodically through direct mail programs. The division also provides the convenience of the Internet for equity loan applications that are available in most states. PMC engages in mortgage banking activities throughout New England and the mid-Atlantic region.
Consumer loan products are underwritten in accordance with accepted industry guidelines including, but not limited to, the evaluation of the credit worthiness of the borrower(s) and collateral. Independent credit reporting agencies and the Fair Isaac scoring model and the analysis of personal financial information are utilized to determine the credit worthiness of potential borrowers. Also, the Consumer Finance division obtains and evaluates an independent appraisal of collateral value to determine the adequacy of the collateral.
Consumer Finance is dedicated to providing a full complement of residential mortgage loan products that are available to meet the financial needs of Websters customers. While the Companys primary lending markets are Connecticut, southern New England and the mid-Atlantic region, we also lend nationally through our National Wholesale Lending Group. We offer customers products including conventional conforming and jumbo fixed rate loans, conforming and jumbo adjustable rate loans, Federal Housing Authority (FHA), Veterans Administration (VA) and state agency mortgage loans through the Connecticut Housing Finance Authority (CHFA). Various programs are offered to support the Community Reinvestment Act goals at the state level. Types of properties consist of one-to-four family residences, owner and non-owner occupied, second homes, construction, permanent and improved single family building lots. Webster both retains and sells servicing on originated loans. The determination to sell or retain servicing is dependent on channel of origin as well as borrower relationships with
Webster. The servicing rights of customer loans are normally retained while the servicing rights of non-customer loans are normally sold.
The National Wholesale Lending production is originated by approved licensed mortgage brokers located throughout the United States and is underwritten, closed and funded by Webster Bank. The majority of this production is sold into the secondary market on a servicing-released basis. The National Wholesale channel operates out of four regional offices in Cheshire, Connecticut; Chicago, Illinois; Phoenix, Arizona; and Seattle, Washington.
PMC loan production is also originated by licensed professionals working in its regional locations. Loans are sold in the secondary market on a servicing-released basis.
Total residential mortgage originations for the group were $3.0 billion in 2006 compared to $3.5 billion in 2005. Income from mortgage banking activities was $8.5 million for 2006 compared to $11.6 million for 2005. The decline is primarily due to a lower of cost or market adjustment recorded on loans held for sale in 2006.
Webster Bank concentrates on offering a range of products including home equity loans and lines of credit, as well as second mortgages. There are no credit card loans in the consumer loan portfolio. The consumer loan portfolio grew 15.7% to a total portfolio of $3.2 billion at December 31, 2006 compared to $2.8 billion at December 31, 2005.
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 workers 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 East Haven, Vernon, Waterford and Westport as well as an office in Harrison, New York. For the year ended December 31, 2006, Webster Insurances revenue was $38.8 million, a decrease of $5.2 million or 11.8%, compared to December 31, 2005, primarily due to reduced retention and a decline in contingent revenue.
Webster Insurance, acting as agent, receives contingent payments under standard agreements written by the insurance carriers; this is the standard practice throughout the industry. Contingent payments to Webster Insurance represent compensation incremental to commissions, typically based on the claims experience of the insured and/or the volume of business written. For additional information see Webster Is Subject To Insurance Industry-Related Risks under Item 1A, Risk Factors, of this report.
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 December 31, 2006 and 2005, there were approximately $2.3 billion and $2.4 billion of client assets under management and administration, of which $1.5 billion and $1.4 billion were under management, respectively. These assets are not included in the Consolidated Financial Statements.
Webster Investment Services, Inc. (WIS) offers securities services, including brokerage and investment advice, and is a registered investment advisor with over 100 registered representatives offering 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
December 31, 2006 and 2005, there were $1.6 billion and $1.5 billion of assets under administration, respectively. These assets are not included in the Consolidated Financial Statements.
For the year ended December 31, 2006, revenue for the combined business units was $27.2 million, an increase of $4.0 million or 17.4%, compared to December 31, 2005.
Websters Commercial Banking group takes a direct relationship approach to providing lending, deposit and cash management services to middle-market companies in our four-state franchise territory and commercial real estate loans principally in the Northeast. Additionally, it serves as a primary referral source to our insurance, wealth management and retail operations. Asset-based lending is located primarily in the Northeast with a national presence, and equipment financing is provided to customers across the United States. This well diversified portfolio, which grew 12.8% to $5.3 billion at December 31, 2006, compared to $4.7 billion at December 31, 2005, is maintained and monitored under a strategy designed to mitigate credit risk, while maximizing returns.
The Middle-Market Division delivers Websters full array of financial services to a diversified group of companies with revenues greater than $10 million, primarily privately held and located within southern New England. Typical loan facilities include lines of credit for working capital, term loans to finance purchases of equipment and commercial real estate loans for owner-occupied buildings. Unit and relationship managers within the Middle-Market Division average over 20 years of experience in their markets. The middle-market loan portfolio increased by 23.1% to a total portfolio of $1.6 billion at December 31, 2006 compared to $1.3 billion at December 31, 2005.
The Commercial Real Estate Division provides variable rate and fixed rate financing alternatives (primarily in Websters core markets) for the purpose of acquiring, developing, constructing, improving or refinancing commercial real estate where the property is the primary collateral securing the loan, and the income generated from the property is the primary repayment source. Loans are typically secured by investment quality real estate, including apartments, anchored retail, industrial and office properties. Loan types include construction, construction mini-perm and permanent loans, in amounts that range from $2 million to $15 million and are diversified by property type and geographic location. The lending group consists of a team of professionals with a high level of expertise and experience. The majority of the lenders have more than 15 years of national lending experience in construction and permanent lending with major banks and insurance companies. The commercial real estate lending portfolio increased by 5.3% to a total portfolio of $1.9 billion at December 31, 2006 compared to $1.8 billion at December 31, 2005.
Webster Business Credit Corporation (WBCC) is Webster Banks asset-based lending subsidiary with headquarters in New York, New York and regional offices in South Easton, Massachusetts; Charlotte, North Carolina; Dallas, Texas; Chicago, Illinois; Atlanta, Georgia; Memphis, Tennessee; and Hartford, Connecticut. Asset-based loans are generally secured by accounts receivable and inventories of the borrower and, in some cases, also include additional collateral such as property and equipment. The asset-based lending portfolio increased by 15.8% to a total portfolio of $766 million at December 31, 2006 compared to $661 million at December 31, 2005.
Center Capital Corporation (Center Capital), a nationwide equipment financing subsidiary of Webster Bank, transacts business with end users of equipment, either by soliciting this business on a direct basis or through referrals from various equipment manufacturers, dealers and distributors with whom it has relationships. The equipment financing portfolio increased by 14.1% to a total portfolio of $890 million at December 31, 2006 compared to $780 million at December 31, 2005.
Center Capital markets its products nationally through a direct sales force of equipment financing professionals who are grouped by customer type or collateral-specific business line. During 2006, financing initiatives encompassed four distinct industry/equipment niches, each operating as a division: Construction and Transportation Equipment Financing, Environmental Equipment Financing, Manufacturing Equipment Financing and General Aviation Equipment Financing.
Within each division, Center Capital seeks to finance equipment that retains value throughout the term of the underlying transaction. Little, if any, residual value risk is taken and, in many instances, financing terms cover only half of the financed equipments useful life. As such, and in exceptional instances where it is forced to repossess its collateral, that equipment may have value equal to or in excess of the defaulted contracts remaining balance. All credit underwriting, contract preparation and closings, as well as servicing (including collections) are performed centrally at Center Capitals headquarters in Farmington, Connecticut.
Budget Installment Corp. (BIC), an insurance premium financing subsidiary headquartered in Rockville Centre, New York, provides insurance premium financing products covering commercial property and casualty policies. Its dedicated staff of insurance premium financing professionals works directly with local, regional and national insurance agents and brokers to market BICs financing products to customers nationwide. BICs portfolio increased by 6.5% to a total portfolio of $90 million at December 31, 2006 compared to $85 million at December 31, 2005.
Webster offers a wide range of deposit and cash management services for clients ranging from sole proprietors to large corporations. For depository needs, we offer products ranging from core checking and money market accounts, to treasury sweep options including repurchase agreements and euro dollar deposits. For clients with more sophisticated cash management needs, available services include ACH origination and payment services such as lockbox for receipts posting, positive pay for fraud control and controlled disbursement for cash forecasting. All of these services are available through our on-line banking system Webster Web-Link (tm) which uses image technology to provide online information to our clients.
Webster Bank manages and controls risk in its loan portfolio through adherence to consistent standards. Written credit policies establish underwriting standards, place limits on exposure and set other limits or standards as deemed necessary and prudent. Exceptions to the underwriting policies arise periodically, and to ensure proper identification and disclosure, additional approval requirements and a tracking requirement for all qualified exceptions have been established. In addition, regular reports are made to senior management and the Board of Directors regarding the credit quality of the loan portfolio.
Risk Management, which is independent of the loan production areas, oversees the loan approval process, ensures adherence to credit policies and monitors efforts to reduce classified and nonperforming assets.
The Loan Review Department, which is independent of the loan production areas and loan approval, performs ongoing independent reviews of the risk management process, the adequacy of loan documentation and the assigned loan risk ratings. The results of its reviews are reported directly to the Audit Committee of the Board of Directors.
The Corporate Compliance Department, which is independent of the operational lines of business, manages and controls compliance risks at the corporate level. Websters Compliance Program defines the infrastructure to support this oversight with defined roles and responsibilities, compliance risk assessment, policies and procedures, training and communication, testing and monitoring, issue management and supervision, evaluation and reporting mechanisms. The findings of the Corporate Compliance Departments oversight activities and line of business compliance risk management controls are reported to the Risk Committee of the Board of Directors.
During 2005, Webster converted its core systems processing to the Fidelity Information Services, Inc. (Fidelity) platform, to provide information technology, application processing and item processing services under a ten-year agreement. Webster is using the new software for core data processing services, enhancing both capacity and speed for customer benefit in consumer, commercial, mortgage and small business accounts in Fidelitys application service provider environment. The migration to the new technology platform was completed in the fourth quarter of 2005. Webster recognized one-time conversion and infrastructure costs of $8.1 million in 2005.
The new system enhances sale and service delivery capabilities across Websters lines of business. Additionally, leveraging the processing capacity of Fidelitys data centers provides Webster with the ability to continue to grow and expand its customer base. Webster will also continue to build out its technology capabilities with projects such as Internet development, automated lending solutions and enhanced cash management systems.
For segment reporting information, see Note 21 of Notes to Consolidated Financial Statements in Item 8 hereof.
The Companys growth and increased market share have been achieved through both internal growth and acquisitions. The Company continually evaluates acquisition opportunities that complement or advance its mission. Acquisitions typically involve the payment of a premium over book and market values and commonly result in one-time charges against earnings for integration and similar costs. Cost-savings, especially incident to in-market acquisitions, are achieved and revenue growth opportunities are enhanced through acquisitions.
The acquisition of NewMil Bancorp, Inc. (NewMil) was completed during 2006. The assets acquired and liabilities assumed were recorded at fair values at the acquisition date, with goodwill and other intangible assets recognized as described in Note 7 of Notes to Consolidated Financial Statements in Item 8 hereof. The results of operations of NewMil are included in the Consolidated Financial Statements for periods subsequent to the date of acquisition.
On October 6, 2006, Webster completed its acquisition of NewMil. NewMil was the holding company for NewMil Bank, a state-chartered savings bank which, on the acquisition date, had $706.1 million in assets, $505.8 million in loans, $615.5 million in deposits and 20 branches in Connecticut. NewMil was merged with and into Webster, with Webster being the surviving corporation, and NewMil Bank was merged with and into Webster Bank, N.A., with Webster Bank being the surviving institution. Under the terms of the merger, Webster acquired NewMil through a tax-deferred, stock-for-stock exchange of all of the outstanding shares of NewMils common stock. For each issued and outstanding share of NewMil common stock, NewMil shareholders received approximately 0.8736 of a share of Webster common stock, which was the equivalent of $41.00 per share. Webster issued a total of 3.6 million common shares with a fair value of approximately $172.9 million.
Websters direct subsidiaries include Webster Bank, Webster Insurance and Fleming, Perry & Cox, Inc. Webster also owns all of the outstanding common stock in the following unconsolidated financial vehicles that have issued trust preferred securities: Webster Capital Trust I and II, Webster Statutory Trust I, Peoples Bancshares Capital Trust II, Eastern Wisconsin Bancshares Capital Trust I and II and NewMil Statutory Trust I. See Note 14 of Notes to Consolidated Financial Statements for additional information.
The following is a brief description of Webster Bank and its principal direct and indirect subsidiaries.
Webster Bank is the primary source of retail activity within the consolidated group. Webster Bank provides banking services through 177 banking offices, 334 ATMs and the Internet. Insurance activities are conducted through Webster Insurance. Residential mortgage origination activity is conducted through both Webster Bank and Peoples Mortgage Corporation.
Webster provides various commercial lending products through subsidiaries of Webster Bank to clients throughout the United States. Webster Business Credit Corporation provides asset-based lending services, Budget Installment Corporation finances insurance premiums for commercial entities, and Center Capital provides equipment financing.
Brokerage and investment products are offered by Webster Investment Services, which is also a registered investment advisor. Fleming, Perry & Cox, Inc., a subsidiary of Webster, provides financial planning services for high net worth individuals.
Webster Mortgage Investment Corporation is a passive investment subsidiary whose primary function is to provide servicing on passive investments, such as residential and commercial mortgage loans transferred from Webster Bank. Webster Preferred Capital Corporation is a real estate investment trust, which holds mortgage assets, principally residential mortgage loans transferred from Webster Bank. Additionally, Webster Bank has various other subsidiaries that are not significant to the consolidated entity.
See Part III, Item 10 of this Form 10-K (Report) for information about our executive officers.
At December 31, 2006, Webster had 3,418 full-time equivalent employees including 3,204 full time and 433 part-time and other employees. The turnover rate for 2006 was 26.3%. None of the employees were represented by a collective bargaining group. Webster maintains a comprehensive employee benefit program providing, among other benefits, group medical and dental insurance, life insurance, disability insurance, and an employee 401(k) investment plan. Management considers relations with its employees to be good. See Note 19 of Notes to Consolidated Financial Statements contained elsewhere within the Report for additional information on certain benefit programs.
Webster is subject to strong competition from banks and other financial institutions, including savings and loan associations, finance companies, credit unions, consumer finance companies and insurance companies. Certain of these competitors are larger financial institutions with substantially greater resources, lending limits, larger branch systems and a wider array of commercial banking services than Webster. Competition from both bank and non-bank organizations is expected to continue.
The banking industry is also experiencing rapid changes in technology. In addition to improving customer services, effective use of technology increases efficiency and enables financial institutions to reduce costs. Technological advances are likely to increase competition by enabling more companies to provide cost effective products and services.
Webster faces substantial competition for deposits and loans throughout its market areas. The primary factors in competing for deposits are interest rates, personalized services, the quality and range of financial services,
convenience of office locations, automated services and office hours. Competition for deposits comes primarily from other commercial banks, savings institutions, credit unions, mutual funds and other investment alternatives. The primary factors in competing for commercial and business loans are interest rates, loan origination fees, the quality and range of lending services and personalized service. Competition for origination of mortgage loans comes primarily from savings institutions, mortgage banking firms, mortgage brokers, other commercial banks and insurance companies.
Supervision and Regulation
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 (BHCA). As such, the Federal Reserve is Websters primary federal regulator, and Webster is subject to extensive regulation, supervision and examination by the Federal Reserve. Webster is subject to the capital adequacy guidelines of the Federal Reserve, which are applied on a consolidated basis. These guidelines require bank holding companies having the highest regulatory ratings for safety and soundness to maintain a minimum ratio of Tier 1 capital to total average assets (or leverage ratio) of 3%. All other bank holding companies are required to maintain an additional capital cushion of 100 to 200 basis points. The Federal Reserve capital adequacy guidelines also require bank holding companies to maintain a minimum ratio of Tier 1 capital to risk-weighted assets of 4% and a minimum ratio of qualifying total capital to risk-weighted assets of 8%. At December 31, 2006, Webster was well capitalized under the capital adequacy guidelines. The Federal Reserve also may set higher minimum capital requirements for a bank holding company whose circumstances warrant it, such as a bank holding company anticipating significant growth. The Federal Reserve has not advised Webster that it is subject to any special capital requirement.
Any bank holding company that fails to meet the minimum capital adequacy guidelines applicable to it is considered to be undercapitalized and is required to submit an acceptable plan to the Federal Reserve to achieve capital adequacy. The Federal Reserve considers a bank holding companys capital ratios and other indicators of capital strength when evaluating proposals to expand banking or non-banking activities, and it may restrict the ability of an undercapitalized bank holding company to pay dividends to its shareholders.
Webster also has made a declaration to the Federal Reserve of its status as a financial holding company under the Gramm-Leach-Bliley Act (GLBA). As a financial holding company, Webster is authorized to engage in certain financial activities that a bank holding company may not engage in. Currently, Webster engages in certain insurance agency activities pursuant to this authority. If a financial holding company fails to remain well capitalized and well managed, the company and its affiliates may not commence any new activity that is authorized particularly for financial holding companies. If a financial holding company remains out of compliance for 180 days or such longer period as the Federal Reserve permits, the Federal Reserve may require the financial holding company to divest either its insured depository institutions or all its non-banking subsidiaries engaged in activities not permissible for a bank holding company. If a financial holding company fails to maintain a satisfactory or better record of performance under the Community Reinvestment Act, it may not commence any new activity authorized particularly for financial holding companies, but may continue to make merchant banking and insurance company investments in the ordinary course of business.
Webster Bank is a national association chartered by the Office of the Comptroller of the Currency (OCC). The OCC is its primary federal regulator, and it is subject to extensive regulation, supervision, and examination by the OCC. In addition, as to certain matters, Webster Bank is subject to regulation by the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve. Webster Bank is subject to leverage and risk-based capital requirements and minimum capital guidelines of the OCC that are similar to those applicable to Webster. At December 31, 2006, Webster Bank was in compliance with all minimum capital requirements. There also are substantial regulatory restrictions on Webster Banks ability to pay dividends to Webster. Under OCC regulations, Webster Bank may pay dividends to Webster without prior regulatory approval so long as it meets its applicable regulatory capital requirements before and after payment of the dividends and its total dividends do not exceed its net income for the calendar year to date plus retained net income for the preceding two years. At December 31, 2006, Webster Bank was in compliance with all applicable minimum capital requirements and had the ability to pay dividends to Webster of $40.6 million without the prior approval of the OCC. Its deposits are insured up to
regulatory limits by the FDIC and are subject to corresponding deposit insurance assessments to maintain the FDIC insurance funds.
Any bank that is less than well-capitalized is subject to certain mandatory prompt corrective actions by its primary federal regulatory agency, as well as other discretionary actions, to resolve its capital deficiencies. The severity of the actions required to be taken increases as the banks capital position deteriorates. A bank holding company must guarantee that a subsidiary bank will meet its capital restoration plan, up to an amount equal to 5% of the subsidiary banks assets or the amount required to meet regulatory capital requirements, whichever is less. In addition, under Federal Reserve policy, a bank holding company is expected to serve as a source of financial strength for, and to commit financial resources to support its subsidiary banks. Any capital loans made by a bank holding company to a subsidiary bank are subordinated to the claims of depositors in the bank and to certain other indebtedness of the subsidiary bank. In the event of the bankruptcy of a bank holding company, any commitment by the bank holding company to a federal banking regulatory agency to maintain the capital of a subsidiary bank would be assumed by the bankruptcy trustee and would be entitled to priority of payment.
Webster Bank is authorized by the OCC to engage in trust activities subject to the OCCs regulation, supervision, and examination. Webster Bank provides trust and related fiduciary services to its customers. Webster Investment Services, Inc. (WIS) is registered as a broker-dealer and investment advisor and is subject to extensive regulation, supervision, and examination by the Securities and Exchange Commission (SEC). Fleming, Perry and Cox (Fleming) is registered as an investment advisor and is subject to extensive regulation, supervision and examination by the SEC. WIS and Fleming also are members of the National Association of Securities Dealers, Inc. (NASD) and are subject to its regulation. WIS is authorized to engage as a broker-dealer and Webster Bank is authorized to engage as an underwriter of municipal securities, and as such they are subject to regulation by the Municipal Securities Rulemaking Board. Webster Insurance is a licensed insurance agency with offices in the states of Connecticut and New York and is subject to registration and supervision by the State of Connecticut Department of Insurance.
Transactions between Webster Bank and its affiliates, including Webster, are governed by sections 23A and 23B of the Federal Reserve Act and Federal Reserve regulations thereunder. Generally, sections 23A and 23B are intended to protect insured depository institutions from suffering losses arising from transactions with non-insured affiliates, by limiting the extent to which a bank or its subsidiaries may engage in covered transactions with any one affiliate and with all affiliates of the bank in the aggregate, and by requiring that such transactions be on terms that are consistent with safe and sound banking practices. Sections 23A and 23B also regulate transactions by a bank with its financial subsidiaries that it may operate as a result of the expanded authority granted under GLBA.
Under GLBA, all financial institutions, including Webster, Webster Bank, and several of their affiliates and subsidiaries, are required to establish policies and procedures to restrict the sharing of nonpublic customer data with nonaffiliated parties at the customers request and to protect customer data from unauthorized access. In addition, the Fair and Accurate Credit Transactions Act of 2003 (FACT Act) includes many provisions concerning national credit reporting standards, and permits consumers, including customers of Webster, to opt out of information sharing among affiliated companies for marketing purposes. The FACT Act also requires banks and other financial institutions to notify their customers if they report negative information about them to a credit bureau or if they are granted credit on terms less favorable than those generally available. The Federal Reserve and the Federal Trade Commission are granted extensive rulemaking authority under the FACT Act, and Webster Bank and its affiliates are subject to those provisions. Webster has developed policies and procedures for itself and its subsidiaries, including Webster Bank, and believes it is in compliance with all privacy, information sharing, and notification provisions of GLBA and the FACT Act.
Under Title III of the USA PATRIOT Act, all financial institutions, including Webster, Webster Bank, and several of their affiliates and subsidiaries, are required to take certain measures to identify their customers, prevent money laundering, monitor customer transactions and report suspicious activity to U.S. law enforcement agencies. Financial institutions also are required to respond to requests for information from federal banking regulatory authorities and law enforcement agencies. Information sharing among financial institutions for the above purposes is encouraged by an exemption granted to complying financial institutions from the privacy provisions of GLBA and other privacy laws. Financial institutions that hold correspondent accounts for foreign banks or provide private
banking services to foreign individuals are required to take measures to avoid dealing with certain foreign individuals or entities, including foreign banks with profiles that raise money laundering concerns, and are prohibited from dealing with foreign shell banks and persons from jurisdictions of particular concern. The primary federal banking regulators and the Secretary of the Treasury have adopted regulations to implement several of these provisions. All financial institutions also are required to establish internal anti-money laundering programs. The effectiveness of a financial institution, such as Webster or Webster Bank, in combating money laundering activities is a factor to be considered in any application submitted by the financial institution under the Bank Merger Act or the BHCA. Webster and Webster Bank have in place a Bank Secrecy Act and USA PATRIOT Act compliance program, and they engage in very few transactions of any kind with foreign financial institutions or foreign persons.
The Sarbanes-Oxley Act (SOA) was adopted for the stated purpose to increase corporate responsibility, enhance penalties for accounting and auditing improprieties at publicly traded companies, and protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. SOA is the most far-reaching U.S. securities legislation enacted in several years. It applies generally to all companies that file or are required to file periodic reports with the SEC under the Securities Exchange Act of 1934 (Exchange Act), including Webster. SOA includes very specific additional disclosure requirements and new corporate governance rules, requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules, and mandates further studies of certain issues by the SEC and the Comptroller General. SOA represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees. In addition, the federal banking regulators have adopted generally similar requirements concerning the certification of financial statements by bank officials.
Home mortgage lenders, including banks, are required under the Home Mortgage Disclosure Act to make available to the public expanded information regarding the pricing of home mortgage loans, including the rate spread between the interest rate on loans and certain Treasury securities and other benchmarks. The availability of this information has led to increased scrutiny of higher-priced loans at all financial institutions to detect illegal discriminatory practices and to the initiation of a limited number of investigations by federal banking agencies and the U.S. Department of Justice. Webster is committed to fulfilling its responsibility to its communities by providing access to all customers and prospects including low and moderate income and minority borrowers. Webster has no information that it or any of its affiliates are the subject of any investigation.
The Federal Deposit Insurance Reform Act of 2005, which was signed into law on February 8, 2006, gave the FDIC increased flexibility in assessing premiums on banks and savings associations, including Webster Bank, to pay for deposit insurance and in managing its deposit insurance reserves. During 2006, the FDIC adopted rules to implement its new authority to set deposit insurance premiums. Under these regulations, all insured depository institutions pay a base rate, which may be adjusted annually up to 3 basis points by the FDIC, and an additional assessment based on the risk of loss to the Deposit Insurance Fund posed by that institution. For an institution, such as Webster Bank, that has a long-term public debt rating, the risk assessment is based on its debt rating and the components of its supervisory rating. For institutions that do not have a long-term public debt rating, the risk assessment is based on certain measurements of its financial condition and its supervisory ratings. Assessment rates set by the FDIC effective January 1, 2007 will range from 5 to 43 basis points. The reform legislation also provided a credit to insured institutions based on the amount of their insured deposits at year-end 1996 which will offset the premiums assessed. Webster Banks credit of $12.6 million is expected to offset its 2007 deposit insurance assessment and at least a portion of its 2008 assessment.
Periodic disclosures by companies in various industries of the loss or theft of computer-based nonpublic customer information have led several members of Congress to call for the adoption of national standards for the safeguarding of such information and the disclosure of security breaches. Several committees of both houses of Congress have discussed plans to conduct hearings on data security and related issues. Webster devotes considerable resources to corporate data security and to protecting its customers identity and privacy, including the use of encryption, multiple authentication and other safeguards.
On October 13, 2006, the Financial Services Regulatory Relief Act of 2006 was signed into law. This Act permits a financial holding company, such as Webster, to increase cross-marketing between its banking subsidiaries, such as Webster Bank, and any commercial companies in which it may invest pursuant to its merchant banking authority under the GLBA. This Act also directs the Federal Reserve and the SEC to engage in joint rulemaking to clarify that traditional banking activities involving some elements of securities brokerage activities may be performed by banks without SEC supervision. A proposed rule was issued for public comment on December 18, 2006. Other provisions of this Act may increase competition between banks and thrifts by increasing parity between them with regard to certain powers, accounting practices, and lending limits.
Webster makes available free of charge on its website (www.wbst.com or www.websteronline.com) its annual report on Form 10-K, its quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Securities Exchange Act of 1934 as soon as practicable after it electronically files such material with, or furnishes it to the Securities and Exchange Commission. Information on Websters website is not incorporated by reference into this report.
The information required by Securities Act Guide 3 Statistical Disclosure by Bank Holding Companies is located on the pages noted below.
An investment in Websters common stock is subject to various risks inherent in its business. The material risks and uncertainties that management believes affect the Company are described below. The risks and uncertainties described below are not the only ones facing Webster. Additional risks and uncertainties that management is not aware of, or that it currently deems immaterial, may also impair business operations.
If any of the following risks actually occur, Websters financial condition and results of operations could be materially and adversely affected. If this were to happen, the value of Websters common stock could decline significantly.
Websters Business Strategy Of Growth Through Acquisitions Could Have An Impact On Its Earnings And Results Of Operations That May Negatively Impact The Value Of The Companys Stock
In recent years, Webster has focused, in part, on growth through acquisitions. In October 2006, Webster completed the acquisition of NewMil Bancorp, Inc., the holding company for NewMil Bank, headquartered in New Milford, Connecticut, a state chartered savings bank.
From time to time in the ordinary course of business, Webster engages in preliminary discussions with potential acquisition targets. The consummation of any future acquisitions may dilute stockholder value.
Although Websters business strategy emphasizes organic expansion combined with acquisitions, there can be no assurance that, in the future, Webster will successfully identify suitable acquisition candidates, complete acquisitions and successfully integrate acquired operations into our existing operations or expand into new markets.
There can be no assurance that acquisitions will not have an adverse effect upon Websters operating results while the operations of the acquired businesses are being integrated into Websters operations. In addition, once integrated, acquired operations may not achieve levels of profitability comparable to those achieved by Websters existing operations, or otherwise perform as expected. Further, transaction-related expenses may adversely affect Websters earnings. These adverse effects on Websters earnings and results of operations may have a negative impact on the value of Websters stock.
Webster faces substantial competition in all areas of its operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national, regional, and community banks within the various markets in which we operate. Webster also faces competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, factoring companies and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than Webster can.
The ability of Webster to compete successfully depends on a number of factors, including, among other things:
Failure to perform in any of these areas could significantly weaken the Companys competitive position, which could adversely affect the growth and profitability, which, in turn, could have a material adverse effect on the Companys financial condition and results of operations.
Websters Business Strategy Of Shifting Its Asset Mix To Reduce The Residential Mortgage Loan Portfolio And Increase Commercial And Consumer Loans Involves Risks
In recent years, Webster has focused on shifting its asset mix to reduce the residential mortgage loan portfolio and increase commercial and consumer loans. In 2006, Webster sold $250 million of its residential mortgage loans and utilized the proceeds to pay down high cost/short term borrowings, and securitized $370 million of residential mortgage loans and retained the resulting securities in order to strengthen its balance sheet. At the end of 2006, commercial loans were $5.3 billion, including (1) commercial and industrial loans at $3.4 billion, up 17.7% compared to balances at December 31, 2005, and (2) commercial real estate loans at $1.9 billion, up 5.3% compared to balances at December 31, 2005. Consumer loans, primarily home equity loans and lines, increased 15.7% to $3.2 billion at December 31, 2006 compared to December 31, 2005. Commercial, commercial real estate and consumer loans comprised 65.8% of total loans at December 31, 2006 compared to 60.7% at December 31, 2005. Commercial and consumer lending typically results in greater yields than traditional residential mortgage lending; however, it also entails more credit risk. Generally speaking, the losses on commercial and consumer portfolios are
more volatile and less predictable than residential mortgage lending, and, consequently, the credit risk associated with such portfolios is higher.
Webster maintains an allowance for credit losses, which is established through a provision for credit losses charged to operations, that represents managements best estimate of probable losses within the existing portfolio of loans and unfunded credit commitments. The allowance, in the judgment of management, is necessary to reserve for estimated credit losses and risks inherent in the loan portfolio and unfunded commitments. The level of the allowance reflects managements continuing evaluation of: industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions; and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for credit losses inherently involves a high degree of subjectivity and requires Webster to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of Websters control, may require an increase in the allowance for credit losses. In addition, bank regulatory agencies periodically review Websters allowance for credit losses and may require an increase in the provision for credit losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for credit losses, Webster will need additional provisions to increase the allowance for credit losses. Any increases in the allowance for credit losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on Websters financial condition and results of operations. See the section captioned Allowance for Credit Losses in Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations, located elsewhere in the Report for further discussion related to the process for determining the appropriate level of the allowance for credit losses.
Changes In Interest Rates Could Impact Websters Earnings And Results Of Operations Which Could Negatively Impact The Value Of Websters Stock
Websters consolidated results of operations depend, to a large extent, on the level of its net interest income, which is the difference between interest income from interest-earning assets, such as loans and investments, and interest expense on interest-bearing liabilities, such as deposits and borrowings. If interest-rate fluctuations cause the cost of interest-bearing liabilities to increase faster than the yield on interest-earning assets, then net interest income for Webster will decrease. If the cost of interest-bearing liabilities declines faster than the yield on interest-earning assets, then net interest income for Webster will increase.
Webster measures its interest-rate risk using simulation analyses with particular emphasis on measuring changes in net income and net economic value in different interest-rate environments. The simulation analyses incorporate assumptions about balance sheet changes, such as asset and liability growth, loan and deposit pricing and changes due to the mix and maturity of such assets and liabilities. Other key assumptions relate to the behavior of interest rates and spreads, prepayments of loans and the run-off of deposits. These assumptions are inherently uncertain and, as a result, the simulation analyses cannot precisely estimate the impact that higher or lower rate environments will have on net income. 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 managements strategies.
While various monitors of interest-rate risk are employed, Webster is unable to predict future fluctuations in interest rates or the specific impact thereof. The market values of most of Websters financial assets are sensitive to fluctuations in market interest rates. Fixed-rate investments, mortgage-backed securities and mortgage loans typically decline in value as interest rates rise. Prepayments on mortgage-backed securities may adversely affect the value of such securities and the interest income generated by them.
Changes in interest rates can also affect the amount of loans that Webster originates, as well as the value of loans and other interest-earning assets and Websters ability to realize gains on the sale of such assets and liabilities. Prevailing interest rates also affect the extent to which Websters borrowers prepay their loans. When interest rates
increase, borrowers are less likely to prepay their loans, and when interest rates decrease, borrowers are more likely to prepay loans. Funds generated by prepayments might be reinvested at a less favorable interest rate. Prepayments may adversely affect the value of mortgage loans, the levels of such assets that are retained in our portfolio, net interest income, loan servicing income and capitalized servicing rights.
Increases in interest rates might cause depositors to shift funds from accounts that have a comparatively lower cost, such as regular savings accounts, to accounts with a higher cost, such as certificates of deposit. If the cost of interest-bearing deposits increases at a rate greater than the yields on interest-earning assets increase, the net interest income will be negatively affected. Changes in the asset and liability mix may also affect the net interest income.
Webster, primarily through Webster Bank and certain non-bank subsidiaries, is subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect Websters lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect Webster in substantial and unpredictable ways. Such changes could subject Webster to additional costs, limit the types of financial services and products Webster may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on Websters business, financial condition and results of operations. While Webster has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur. See the section captioned Supervision and Regulation in Item 1 of this report for further information.
The Attorneys General of the states of New York and Connecticut have been investigating insurance brokerage firms regarding certain compensation arrangements between insurance brokers and insurance companies. One of the areas of focus of these inquiries to date has been on contingency or override payments that insurance companies pay based on the overall relationship and services provided. Such payments are generally in accordance with longstanding industry practice and may be based upon a variety of factors, including, but not limited to, aggregate volume, profitability, and persistency of insurance policies placed with the insurance company. Recent settlement agreements entered into between insurance brokers and the Attorneys General of some states relating to contingency payments have included significant penalties and the imposition of disclosure requirements on the broker. Webster Insurance acts principally as an agent, although it has some brokerage business.
Webster Insurance receives contingent payments from insurance carriers. Webster Insurance has received and responded to a request for information from the Connecticut Department of Insurance, and a subpoena from the Office of the Attorney General of the State of Connecticut regarding its compensation arrangements with insurance carriers. It is the Companys understanding that Webster Insurances receipt of these inquiries is part of a broad review of the insurance industry and that others in the industry have received similar inquiries. Webster Insurance has fully cooperated with the Attorney General and Department of Insurance inquiries and is not aware of any claims with respect to compensation arrangements with insurance carriers.
While it is not possible to predict the outcome of these inquiries, if contingent compensation agreements were to be restricted or no longer permitted or if Webster Insurance were to be subject to monetary penalties in connection therewith, Websters financial condition and results of operations may be adversely affected. Webster will continue to monitor industry developments in these areas, as well as compliance and disclosure practices.
Management regularly reviews and updates Websters internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is
based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on Websters business, results of operations and financial condition.
From time to time, Webster may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, Webster may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of Websters system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on Websters business, results of operations and financial condition.
Webster May Not Pay Dividends If It Is Not Able To Receive Dividends From Its Subsidiary, Webster Bank
Cash dividends from Webster Bank and existing liquid assets are the principal sources of funds for paying cash dividends on Websters common stock. Unless the Company receives dividends from Webster Bank or chooses to use liquid assets, the Company may not be able to pay dividends. Webster Banks ability to pay dividends is subject to its ability to earn net income and to meet certain regulatory requirements.
Websters main sources of liquidity are dividends from Webster Bank, investment income and net proceeds from capital offerings and borrowings. The main uses of liquidity are purchases of investment securities, the payment of dividends to common stockholders, repurchases of the Companys common stock, and the payment of interest on borrowings and capital securities. There are certain regulatory restrictions on the payment of dividends by Webster Bank to Webster. See Note 16 of Notes to Consolidated Financial Statements contained elsewhere within this Report for further information on such dividend restrictions.
Websters success depends, in large part, on its ability to attract and retain key people. Competition for the best people in most activities engaged in by Webster can be intense and the Company may not be able to hire people or to retain them. The unexpected loss of services of one or more of Websters key personnel could have a material adverse impact on the business because of their skills, knowledge of the market, years of industry experience and the difficulty of promptly finding qualified replacement personnel. Webster does not currently have employment agreements with any of its executive officers.
Webster relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in the customer relationship management, general ledger, deposit, loan and other systems. While Webster has policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of information systems could damage Websters reputation, result in a loss of customer business, subject Webster to additional regulatory scrutiny, or expose Webster to civil litigation and possible financial liability, any of which could have a material adverse effect on Websters financial condition and results of operations.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Websters future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in operations. Many of Websters competitors because of their larger size and available capital have substantially greater resources to invest in technological improvements. Webster may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on Websters business and, in turn, its financial condition and results of operations.
Webster Is Subject To Claims And Litigation Pertaining To Fiduciary Responsibility
From time to time, customers make claims and take legal action pertaining to Websters performance of its fiduciary responsibilities. Whether customer claims and legal action related to Websters performance of its fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to Webster they may result in significant financial liability and/or adversely affect the market perception of Webster and its products and services, as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on Websters business, which, in turn, could have a material adverse effect on the Companys financial condition and results of operations.
Webster has no unresolved comments from the SEC staff.
At December 31, 2006, Webster Bank had 177 banking offices, which includes: 35 banking offices, including its main office, in New Haven County; 49 banking offices in Hartford County; 28 banking offices in Fairfield County; 16 banking offices in Litchfield County; 5 banking offices in Middlesex County; 2 banking offices in Tolland County; and 3 banking offices in New London County. It also maintains 7 banking offices in New York State, 22 in Massachusetts and 10 in Rhode Island. Of the 177 offices, 77 offices are owned and 100 offices are leased. Lease expiration dates range from 1 to 81 years with renewal options of 2 to 35 years. Webster Financial Advisors, headquartered in Stamford, Connecticut, has offices in Hartford, New Haven, Waterbury and Providence, Rhode Island. The National Wholesale Lending Group maintains regional offices in Cheshire, Connecticut; Chicago, Illinois; Phoenix, Arizona; and Seattle, Washington.
Subsidiaries maintain the following offices: Webster Insurance is headquartered in Meriden, Connecticut and has offices in several Connecticut communities, including East Haven, Vernon, Waterford and Westport as well as an office in Harrison, New York. Webster Investment Services, Inc. is headquartered in Kensington, Connecticut with sales offices located throughout Websters branch network. Center Capital is headquartered in Farmington, Connecticut and has offices in Brookfield, Connecticut; Blue Bell, Pennsylvania; and Schaumburg, Illinois. WBCC is headquartered in New York, New York with offices in Atlanta, Georgia; South Easton, Massachusetts; Chicago, Illinois; Dallas, Texas; Charlotte, North Carolina; Memphis, Tennessee; and Hartford, Connecticut. BIC is headquartered in Rockville Centre, New York. Peoples Mortgage Corporation has offices in, Andover, Massachusetts; Hamden, Connecticut; Severna Park and Rockville, Maryland.
The total net book value of properties and equipment owned at December 31, 2006 was $195.9 million. See Note 8 of Notes to Consolidated Financial Statements elsewhere in this Report for additional information.
There are no material pending legal proceedings, other than ordinary routine litigation incident to the registrants business, to which Webster is a party or of which any of its property is subject.
During the fourth quarter of 2006, no matters were submitted to a vote of Webster security holders.
The common shares of Webster trade on the New York Stock Exchange under the symbol WBS.
The following table sets forth for each quarter of 2006 and 2005 the intra-day high and low sales prices per share of common stock as reported by the NYSE and the cash dividend declared per share. On January 31, 2007, the closing market price of Webster common stock was $49.82. Webster increased its quarterly dividend to $0.27 per share in the second quarter of 2006.
Webster had 10,943 holders of record of common stock and 56,465,108 shares outstanding on January 31, 2007. The number of shareholders of record was determined by American Stock Transfer and Trust Company.
The payment of dividends is subject to various restrictions, none of which is expected to limit any dividend policy that the Board of Directors may in the future decide to adopt. Payment of dividends to Webster from Webster Bank is subject to certain regulatory and other restrictions. Under OCC regulations, Webster Bank may pay dividends to Webster without prior regulatory approval so long as it meets its applicable regulatory capital requirements before and after payment of such dividends and its total dividends do not exceed its net income to date over the calendar year plus retained net income over the preceding two years. At December 31, 2006, Webster Bank was in compliance with all applicable minimum capital requirements and had the ability to pay dividends of $40.6 million to Webster without the prior approval of the OCC.
If the capital of Webster is diminished by depreciation in the value of its property or by losses, or otherwise, to an amount less than the aggregate amount of the capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets, no dividends may be paid out of net profits until the deficiency in the amount of capital represented by the issued and outstanding stock of all classes having a preference upon the distribution of assets has been repaired. See Supervision and Regulation section contained elsewhere within the Report for additional information on dividends.
No unregistered securities were sold by Webster within the last three years. Registered securities were exchanged either as part of an employee and director stock compensation plan or as consideration for acquired entities.
The following table provides information with respect to any purchase of shares of Webster common stock made by or on behalf of Webster or any affiliated purchaser for the quarter ended December 31, 2006. Management may engage in future share repurchases as liquidity conditions permit and market conditions warrant.
Information regarding stock-based compensation awards outstanding and available for future grants as of December 31, 2006, segregated between stock-based compensation plans approved by shareholders and stock-based compensation plans not approved by shareholders, is presented in the table below. Additional information is presented in Note 20, Stock-Based Compensation Plans, in the Notes to Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, within this report.
The performance graph compares Websters cumulative shareholder return on its common stock over the last five fiscal years to the cumulative total return of the Standard & Poors 500 Index (S&P 500 Index) and the SNL All Bank and Thrift Index. Total shareholder return is measured by dividing total dividends (assuming dividend reinvestment) for the measurement period plus share price change for a period by the share price at the beginning of the measurement period. Websters cumulative shareholder return over a five-year period is based on an initial investment of $100 on December 31, 2001.
Comparison of Five Year Cumulative Total Return Among
Webster, S&P 500 Index and SNL All Bank & Thrift Index
Sources : SNL Financial LC, Bloomberg L.P.
The following discussion should be read in conjunction with the Consolidated Financial Statements of Webster Financial Corporation and the Notes thereto included elsewhere in the Report (collectively, the Financial Statements).
Critical accounting estimates are necessary in the application of certain accounting policies and procedures, and are particularly susceptible to significant change. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. Management believes that the most critical accounting policies, which involve the most complex or subjective decisions or assessments, are as follows:
Arriving at an appropriate level of allowance for credit losses involves a high degree of judgment. The allowance for credit losses, which comprises the allowance for loan losses and the reserve for unfunded credit commitments, provides for probable losses based upon evaluations of known and inherent risks in the loan portfolio and in unfunded credit commitments. To assess the adequacy of the allowance, management considers historical information as well as the prevailing business environment, as it is affected by changing economic conditions and various external factors, which may impact the portfolio in ways currently unforeseen. The allowance is increased by provisions for credit losses and by recoveries of loans previously charged-off and reduced by loans
charged-off. For a full discussion of the methodology of assessing the adequacy of the allowance for credit losses, see the Asset Quality section elsewhere within Managements Discussion and Analysis of Financial Condition and Results of Operations.
Webster, in part, has increased its market share through acquisitions accounted for under the purchase method, which requires that assets acquired and liabilities assumed be recorded at their fair values estimated by means of internal or other valuation techniques. These valuation estimates affect the measurement of goodwill and other intangible assets recorded in the acquisition. Goodwill is subject to ongoing periodic impairment tests and is evaluated using various fair value techniques including multiples of revenue, price/equity and price/earnings ratios.
Certain aspects of income tax accounting require management judgment, including determining the expected realization of deferred tax assets. Such judgments are subjective and involve estimates and assumptions about matters that are inherently uncertain. Should actual factors and conditions differ materially from those used by management, the actual realization of the net deferred tax assets could differ materially from the amounts recorded in the financial statements.
Deferred tax assets generally represent items that can be used as a tax deduction or credit in future income tax returns, for which a financial statement tax benefit has already been recognized. The realization of the net deferred tax asset generally depends upon future levels of taxable income and the existence of prior years taxable income to which carry back refund claims could be made. Valuation allowances are established against those deferred tax assets determined not likely to be realized (a full valuation allowance has been established for the Connecticut, Massachusetts and Rhode Island portion of the net deferred tax assets).
Deferred tax liabilities represent items that will require a future tax payment. They generally represent tax expense recognized in the Companys financial statements for which a payment has been deferred, or a deduction taken on the Companys tax return but not yet recognized as an expense in the financial statements. Deferred tax liabilities are also recognized for certain non-cash items such as certain acquired intangible assets subject to amortization which results in future financial statement expenses that are not deductible for tax purposes.
For more information about income taxes, see Note 9 of Notes to Consolidated Financial Statements included elsewhere within this Report.
The determination of the obligation and expense for pension and other postretirement benefits is dependent upon certain assumptions used in calculating such amounts. Key assumptions used in the actuarial valuations include the discount rate, expected long-term rate of return on plan assets and rates of increase in compensation and health care costs. Actual results could differ from the assumptions and market driven rates may fluctuate. Significant differences in actual experience or significant changes in the assumptions may materially affect the future pension and other postretirement obligations and expense. See Note 19 of Notes to Consolidated Financial Statements for further information.
Results of Operations
Websters net income was $133.8 million or $2.47 per diluted share in 2006, compared to $185.9 million or $3.43 per diluted share in 2005, a decrease of 28%. The $52.1 million decline in net income is primarily due to charges of $57.0 million ($37.0 million after taxes, or $0.69 per diluted share) related to the balance sheet repositioning actions taken in the fourth quarter.
Results for 2006 reflect Websters continued focus on growing loans and deposits, while reducing exposure to rising interest rates by paying down borrowings and increasing tangible capital. A 13 basis point decrease in the net
interest margin for 2006, when compared to the prior year, was due to the flattening of the yield curve including especially the effect of rising short-term interest rates. The effect of these rates has been partially offset by loan portfolio growth. Average earning assets increased $350.3 million or 2.2% with an increase of $870.1 million or 7.3% in loans, primarily higher yielding commercial and consumer loans, and an increase in loans held for sale of $56.2 million or 24.2%, partially offset by a decrease in securities of $581.5 million or 15.5% when compared to 2005.
Non-interest income decreased by $50.4 million, or 22.8%, in 2006 compared to a year ago, due to the loss of $51.3 million on write-down and subsequent sale of available for sale mortgage-backed securities and the loss of $5.7 million on the sale of mortgage loans. Both of these losses were related to the balance sheet repositioning actions that were announced and completed in the fourth quarter of 2006. Insurance revenues decreased $5.2 million or 11.8%, the result of reduced retention and a decline in contingent revenue. These decreases were partially offset by an increase in deposit service fees of $10.8 million, or 12.6% compared to 2005.
Non-interest expenses increased $19.4 million, or 4.3%, to $474.9 million compared to 2005. The increase reflects the impact of the NewMil acquisition, investments in customer facing personnel and de novo branch expansion, partially offset by the $8.1 million of conversion and infrastructure costs incurred in 2005.
In July 2006, Webster Bank reached an informal agreement with the Office of the Comptroller of the Currency to address general bank compliance, including Bank Secrecy Act and related money laundering risks, flood acts compliance and the internal audit program. These increased compliance efforts, already well under way and receiving significant management attention, are not expected to have a material impact on Websters operations or earnings.
Table 1: Three-year average balance sheet and net interest margin.
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 $508.6 million in 2006, compared to $517.3 million in 2005, a decrease of $8.7 million or 1.7%. Net interest income is affected by changes in interest rates, by loan and deposit pricing strategies and competitive conditions, the volume and mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. As a result of the balance sheet repositioning in the fourth quarter, the net interest margin for the three months ended December 31, 2006 was 3.23%, an increase of 22 basis points compared to the three months ended September 30, 2006.
These declines are largely due to the interest rate environment, as the costs of deposits and borrowings have increased faster than the yields on earning assets. For the year ended December 31, 2006, the yield on interest-earning assets increased 75 basis points while the cost of interest-bearing liabilities rose 91 basis points. As a result, the net interest margin for the year was 3.16%, a decline of 13 basis points compared to 2005.
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 Websters 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.
Table 2: Net interest income rate/volume analysis.
The Federal Reserve Board influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. The loan portfolio is significantly affected by changes in the prime interest rate. The prime interest rate, which is the rate offered on loans to borrowers with strong credit ratings, began 2004 at 4.00%, increased 25 basis points at the end of the second quarter, 50 basis points during the third quarter and 50 basis points during the fourth quarter and ended the year at 5.25%. During 2005, the prime rate increased 50 basis points in each of the four quarters to end the year at 7.25%. During 2006, the prime interest rate increased 50 basis points in each of the first two quarters to end the year at 8.25%. The federal funds rate, which is the cost of immediately available overnight funds, fluctuated in a similar manner. It began 2004 at 1.00%, increased 25 basis points at the end of the second quarter, 50 basis points during the third quarter and 50 basis points during the fourth quarter to end the year at 2.25%. During 2005, the federal funds rate increased 50 basis points in each of the four quarters to end the year at 4.25%. During 2006, the federal funds rate increased 50 basis points in each of the first two quarters to end the year at 5.25%.
Interest income (on a fully tax-equivalent basis) increased $143.6 million, or 16.3%, to $1.0 billion for 2006 as compared to 2005. The increase in short-term interest rates had a favorable impact on interest sensitive loans as well as higher rates on new volumes. Most of the growth occurred in higher yielding commercial and consumer loans. Also contributing was the increase in the volume of earning assets, with most of that growth occurring in the loan portfolio.
The yield earned on earning assets increased 75 basis points for the year ended December 31, 2006 to 6.25% compared to 5.50% for 2005 as a result of a rising interest rate environment. The loan portfolio yield increased 81 basis points to 6.59% for the year ended December 31, 2006 and comprised 78.3% of average interest-earning assets compared to the loan portfolio yield of 5.78% and 74.6% of average earning assets for the year ended December 31, 2005. Additionally, the yield on securities was 4.98%, a 30 basis point improvement over 2005.
Earning assets increased during 2006, averaging $16.3 billion, up from $16.0 billion in 2005. Strong growth occurred in the loan portfolio, particularly commercial loans and consumer loans. In total, the average loan portfolio increased by 7.3% over 2005. Securities decreased during the year as a result of the repositioning of the securities portfolio during the fourth quarter of 2006 when the $1.9 billion available for sale mortgage-backed securities portfolio was sold.
Interest expense for the year ended December 31, 2006 increased $151.7 million, or 42.8%, compared to 2005. The increase was primarily due to the rising short-term interest rates and changing consumer preference for higher yielding products. The amount of borrowings declined as cash flows from the investment portfolio were used to reduce these high-cost funding sources and deposit growth was used primarily to fund loan growth, and also from the balance sheet repositioning that took place in the fourth quarter of 2006.
The cost of interest-bearing liabilities was 3.16% for the year ended December 31, 2006, an increase of 91 basis points compared to 2.25% for 2005. Deposit costs for the year ended December 31, 2006 increased to 2.57% from 1.67% in 2005, an increase of 90 basis points. Total borrowing costs for the year ended December 31, 2006 increased 128 basis points to 5.01% from 3.73% for 2005.
The provision for credit losses was $11.0 million for the year ended December 31, 2006, an increase of 15.8% compared to $9.5 million for the year ended December 31, 2005. The increase in provision is primarily due to a higher level of net-charge offs and growth in both the commercial and consumer loan portfolios. During 2006, net charge-offs were $16.4 million compared to $3.2 million in 2005. See Tables 10 through 15 for information on the allowance for credit losses, net charge-offs and nonperforming assets.
Management performs a quarterly review of the loan portfolio and unfunded commitments to determine the adequacy of the allowance for credit losses. Several factors influence the amount of the provision, primarily loan growth and portfolio mix, net charge-offs and the level of economic activity. At December 31, 2006, the allowance for credit losses totaled $155.0 million or 1.20% of total loans compared to $155.6 million or 1.27% at December 31, 2005. See the Allowance for Credit Losses Methodology section later in the Managements Discussion and Analysis for further details.
Table 3: Non-interest income comparison of 2006 to 2005.
The $50.4 million, or 22.8%, decrease in non-interest income over the prior year is primarily attributable to managements decision to sell the mortgage-backed securities classified as available for sale. A $48.9 million loss was recognized at September 30, 2006 for the write-down of these securities available for sale to fair value. During the fourth quarter of 2006, an additional loss of $2.4 million, included in net gain on securities transactions, was recognized upon completion of the sale. Additionally, as part of Websters balance sheet repositioning actions, the Company recognized a $5.7 million loss on the sale of $250 million of residential mortgage loans in the fourth quarter of 2006. The total impact of the balance sheet repositioning actions was a reduction in non-interest income of $57.0 million for the year ended December 31, 2006. Excluding the balance sheet actions cited above, non-interest income for the year ended December 31, 2006 increased 3.0% when compared to the prior year as a result of increases in deposit service fees of $10.8 million, wealth and investment service fees of $4.0 million and loan related fees of $1.2 million, which were partially offset by decreases in insurance revenue of $5.2 million due to reduced retention and a decline in contingent revenues, and mortgage banking activities of $3.0 million primarily due to a lower of cost or market adjustment recorded in 2006. See below for further discussion of various components of non-interest income.
Deposit Service Fees. Deposit service fees increased $10.8 million or 12.6% compared to 2005. The increase was primarily due to increases in insufficient fund fees, electronic overdraft fees, NSF fees, electronic bill pay services related to account growth and cross-sell, including from de novo branches and the addition of NewMil Bancorp in the fourth quarter of 2006. Teller checks and money order fees increased $0.8 million and ATM surcharge fees increased $0.7 million.
Insurance Revenue. Insurance revenue decreased $5.2 million or 11.8% compared to 2005, primarily due to reduced retention and a decline in contingent revenue. The balance is the result of market conditions and increasing pricing pressure in both commercial and personal lines.
Loan Related Fees. Loan related fees increased by $1.2 million or 3.5% primarily due to higher commercial real estate prepayment fees of $0.9 million, higher credit line usage fees of $0.7 million, higher origination fees on mortgages of $0.5 million and lower amortization of mortgage servicing rights of $0.5 million due to lower prepayments, partially offset by lower application fees of $1.2 million.
Wealth and Investment Services. Investment service fees increased $4.0 million or 17.4% compared to 2005. The increase is due to an increase in sales of investment services and a full years revenue from J. Bush & Co. which was acquired in 2005.
Table 4: Non-interest expense comparison of 2006 to 2005.
Total non-interest expenses for the year ended December 31, 2006 were $474.9 million, an increase of $19.4 million or 4.3% compared to December 31, 2005. Non-interest expense for the year ended December 31, 2006 increased as a result of the acquisition of NewMil on October 6, 2006 which added $3.0 million of one-time acquisition costs and $3.4 million of NewMils costs of ongoing operations. The 2006 non-interest expense also includes $0.4 million from the early termination of two leased properties, $0.2 million in leasehold improvement write-offs, $0.5 million in regulatory consulting expenses and the expenses from the opening of six de novo branches throughout 2006. Partially offsetting the increase were decreases of $5.4 million in the amortization of intangible assets due to core deposit intangibles from several past acquisitions becoming fully amortized during the year and the absence of the conversion and infrastructure costs ($8.1 million in 2005), as the core banking systems were fully in place during 2006. Further changes in various components of non-interest expense are discussed below.
Compensation and Benefits. Total compensation and benefits increased by $14.3 million or 6.0% from 2005. The increase was primarily due to increases in compensation of $10.2 million, benefits of $0.8 million, recruiting expenses of $0.8 million and temporary help of $0.6 million. The increase in compensation is attributed to merit increases, increased staff to support loan growth, staffing increases related to de novo branch expansion and the continued build out of compliance functions which is expected to continue through 2007. The acquisition of NewMil in the fourth quarter of 2006 also impacted the increase; the full effect of the acquisition will occur in 2007.
Occupancy. Total occupancy expense increased by $6.1 million or 14.1% compared to December 31, 2005. The increase in occupancy is primarily due to expenses related to the de novo branch expansion program, higher rent expense and increased utilities, as well as the addition of NewMil.
Furniture and Equipment. Total furniture and equipment expense increased by $5.8 million or 11.6% compared to December 31, 2005. The increase is primarily due to higher depreciation on data processing equipment, increases in equipment maintenance contracts and service costs related to core banking systems.
Income tax expense decreased from the prior year principally due to a lower level of pre-tax income in 2006. The effective tax rate decreased to 30.7% in 2006, from 32.0% in the prior year. The lower effective rate is attributable to the lower level of pre-tax income in 2006 coupled with higher levels of tax-exempt interest income, dividends-received deductions, and state and local tax expense in 2006, as compared to the prior year.
Net income for 2005 was $185.9 million, or $3.43 per diluted common share, an increase of $32.1 million, or 20.8%, compared to net income of $153.8 million, or $3.00 per diluted common share for 2004. Net interest income
rose to $517.3 million for 2005, an increase of $49.1 million, or 10.5%. The net interest margin for 2005 was 3.29%, up 18 basis points from 2004. Non-interest income reached $220.9 million, an increase of $1.2 million, or 0.5% compared to 2004 and non-interest expenses increased $8.4 million, or 1.9% compared to 2004.
Net interest income totaled $517.3 million for the year ended December 31, 2005, an increase of $49.1 million, or 10.5%, compared to 2004 and resulted from the growth in average earning assets, primarily in the loan portfolio, up $1.2 billion or 11.3% over 2004, partially offset by a reduction in securities and short-term investments of $535.8 million from 2004. Additionally, the increasing interest rate environment during much of 2005 contributed to the increase in net interest income.
On a fully taxable-equivalent basis, the net interest margin increased to 3.29% in 2005 from 3.11% in 2004. The improvement is due to the growth in higher-yielding loans funded by deposits and the de-leveraging in the fourth quarter of 2004. While the margin improved year-over-year, the margin declined in the third and fourth quarters of 2005 due to the flattening of the yield curve. See Table 2 above for further information.
Total interest income increased $139.7 million, or 19.1%, to $871.8 million for 2005 as compared to $732.1 million for 2004. The rising interest rate environment during 2005 was responsible for most of the increase in interest income. Also contributing was the increase in the volume of earning assets, with most of that growth occurring in the loan portfolio.
The yield earned on earning assets increased during 2005 to 5.50% from 4.85% as a result of a higher interest rate environment when compared to 2004. The yield on loans for 2005 was 5.78%, up 67 basis points, while the yield on securities was 4.68%, a 45 basis point improvement over 2004.
Earning assets increased during 2005, averaging $16.0 billion, up from $15.2 billion in 2004. Strong growth occurred in the loan portfolio, particularly commercial loans and commercial real estate loans. In total, the average loan portfolio increased by 11.3% over 2004. Securities decreased during the year as a result of the de-leveraging in the fourth quarter of 2004 when securities of $750 million were sold to reduce borrowings.
Interest expense increased $90.6 million, or 34.3%, to $354.5 million as compared to $263.9 million for 2004. The increase was entirely due to the higher interest rate environment, while the volume increase in deposits was offset by a decline in borrowings.
The cost of interest-bearing liabilities increased 49 basis points to 2.25% from 1.76% in 2004. Deposit costs were 1.67% for the year, up 43 basis points from the prior year, as higher interest rates were paid on deposit accounts. The cost of FHLB advances, Fed funds and repurchase agreements and other borrowings all rose due to higher wholesale funding rates.
Total interest-bearing liabilities increased during 2005 by $788.2 million or 5.3% to $15.7 billion. Total deposits averaged $11.3 billion for the year, an increase of $1.6 billion, or 16.4%. Since the growth in deposits exceeded the increase in earning assets, the excess was used to reduce borrowings. As a result, total borrowings declined $805.7 million. Also contributing to the decline in borrowings was the de-leveraging in the fourth quarter of 2004.
The provision for credit losses declined to $9.5 million for the year ended December 31, 2005 from $18.0 million a year earlier, a decrease of 47%. The decrease in the provision is primarily a result of a reduced level of net-charge offs and continued strong asset quality. During 2005, net charge-offs were $3.2 million compared to $10.3 million in 2004, a decrease of 69%. See Tables 10 through 15 for information on the allowance for credit losses, net charge-offs and nonperforming assets.
Management performs a quarterly review of the loan portfolio and unfunded commitments to determine the adequacy of the allowance for credit losses. At December 31, 2005, the allowance for credit losses totaled $155.6 million or 1.27% of total loans compared to $150.1 million or 1.28% at the prior year end. See the Allowance for Credit Losses Methodology section later in this Managements Discussion and Analysis for further details.
Table 5: Non-interest income comparison of 2005 to 2004.
The $1.2 million increase in non-interest income over the prior year is the result of increases in deposit service fees of $8.2 million, loan fees of $4.7 million and other income of $2.7 million, offset by a decrease in gain on sale of securities of $10.7 million and a $3.8 million loss of revenue from financial advisory services due to the sale of Duff and Phelps in the first quarter of 2004. See below for further discussion on various components of non-interest income.
Deposit Service Fees. Deposit service fees increased $8.2 million or 10.6% compared to 2004. The increase was primarily due to increases in insufficient funds fees of $6.0 million, check card fees of $2.9 million and account service fees from HSA of $2.8 million. These increases were partially offset by a decrease in account analysis fees of $2.1 million.
Insurance Revenue. Insurance revenue increased $0.5 million or 1.2%. The competitive environment for pricing and business development impacted the growth of revenues during the year. Also affecting revenues was the sale of the Pension and 401(k) Third Party Administration business in July 2005.
Loan Related Fees. Loan related fees increased by $4.7 million or 16.3% primarily due to higher loan prepayment penalties of $1.8 million, commercial loan commitment fees of $1.2 million, commercial late charges of $0.5 million and lower amortization of mortgage servicing rights of $1.0 million due to lower prepayments.
Other Income. Other income increased in 2005 by $2.7 million or 35.8% primarily due to the recognition of realized and unrealized gains of $2.5 million related to Websters direct investments.
Table 6: Non-interest expenses comparison of 2005 to 2004.
Total non-interest expense increased by $8.4 million or 1.9% compared to 2004 and $54.2 million or 13.5% excluding the de-leverage charge in 2004. The increase is the result of the acquisitions of FIRSTFED AMERICA BANCORP, INC. (FIRSTFED) in May 2004 and HSA Bank in February 2005, adding $9.1 million and $7.6 million, respectively, of non-interest expense in 2005 that did not exist in the prior year. Also contributing to the increase was $8.1 million in costs related to the conversion and installation of the new core banking systems and an increase of $4.5 million related to the de novo branch expansion program. Offsetting these increases was the $45.8 million of debt prepayment expense due to the de-leveraging program that was completed in 2004. Further changes in various components of non-interest expense are discussed below.
Compensation and Benefits. Total compensation and benefits increased by $22.1 million or 10.1% from 2004. The increase was primarily due to increases in compensation of $14.3 million, commissions of $4.4 million and temporary help of $3.9 million. The increase in compensation can be attributed to the full year impact of acquisitions, increased staff to support loan growth and de novo branch expansion and merit increases. The increase in temporary help is primarily related to the conversion and installation of new core banking systems.
Occupancy. Total occupancy expense increased by $7.5 million or 20.9% compared to 2004. The increase in occupancy is primarily due to expenses related to the de novo branch expansion program, higher rent expense and increased utilities and snow removal costs.
Furniture and Equipment. Total furniture and equipment expense increased by $12.6 million or 33.5% compared to 2004. The increase is primarily due to higher depreciation on data processing equipment, increases in equipment maintenance contracts and service costs related to the new core banking systems.
Conversion and Infrastructure Costs. These represent costs such as training, overtime, consulting, marketing, statement rendering and other miscellaneous costs related to the installation of the new core banking systems.
Income tax expense increased from the prior year primarily due to a higher level of pre-tax income in 2005, partially offset by the effect of a higher level of tax-exempt income in 2005. Tax expense in 2004 was impacted by the $2.0 million favorable resolution of tax audits. As a result, the effective tax rate increased to 32.0% in 2005, as compared to 30.9% in the prior year.
Webster had total assets of $17.1 billion at December 31, 2006, a decrease of $739.1 million, or 4.1%, from the previous year end. The decline was primarily due to the balance sheet repositioning actions taken during the fourth
quarter: the sale of the $1.9 billion mortgage-backed securities portfolio classified as available for sale; and the sale of $250 million in residential mortgage loans. Total liabilities decreased $1.0 billion with total borrowings decreasing $1.8 billion, partially offset by an $827.3 million increase in total deposits. The decrease in total borrowings was primarily due to the pay down of wholesale borrowings as part of the balance sheet repositioning actions. The increase in total deposits for the year is related to contributions from the branches acquired as part of the NewMil acquisition, the de novo branching program which added six new retail banking branches and growth in health savings account deposits.
Shareholders equity was $1.9 billion at December 31, 2006, up $229.6 million or 13.9% over the prior year end. This increase was primarily due to $172.8 million of additional capital related to the acquisition of NewMil, $133.8 million in net income for the year and a $31.8 million decrease in the after-tax net unrealized losses on the available for sale securities portfolio due primarily to Websters sale of the mortgage-backed securities portfolio, partially offset by $63.2 million of common stock repurchases, $57.0 million of common stock dividend payments and a $9.7 million charge to equity related to the adoption of SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans.
Webster, either directly or through Webster Bank, maintains an investment securities portfolio that is primarily structured to provide a source of liquidity for operating needs, to generate interest income and to provide a means to balance interest-rate sensitivity. The investment portfolio is classified into three major categories: available for sale, held to maturity and trading. At December 31, 2006, the combined investment portfolios of Webster and Webster Bank totaled $2.0 billion. At December 31, 2006, Webster Banks portfolio consisted primarily of mortgage-backed securities held to maturity and Websters portfolio consisted primarily of equity and corporate trust preferred securities available for sale. See Note 3 of Notes to Consolidated Financial Statements contained elsewhere within the Report for additional information.
Webster Bank may acquire, hold and transact various types of investment securities in accordance with applicable federal regulations and within the guidelines of its internal investment policy. The type of investments that it may invest in include: interest-bearing deposits of federally insured banks, federal funds, U.S. government treasury and agency securities, including mortgage-backed securities (MBS) and collateralized mortgage obligations (CMOs), private issue MBSs and CMOs, municipal securities, corporate debt, commercial paper, bankers acceptances, trust preferred securities, mutual funds and equity securities subject to restrictions applicable to federally charted institutions.
Webster Bank has the ability to use the investment portfolio, as well as interest-rate financial instruments within internal policy guidelines, to hedge and manage interest-rate risk as part of its asset/liability strategy. See Note 17 of Notes to Consolidated Financial Statements contained elsewhere within the Report for additional information concerning derivative financial instruments.
The securities portfolios are managed in accordance with regulatory guidelines and established internal corporate investment policies. These policies and guidelines include limitations on aspects such as investment grade, concentrations and investment type to help manage risk associated with investing in securities. While there may be no statutory limit on certain categories of investments, the OCC may establish an individual limit on such investments, if the concentration in such investments presents a safety and soundness concern.
Total securities, excluding the trading portfolio, decreased by $1.7 billion from December 31, 2005. The available for sale securities portfolio decreased by $2.1 billion while the held to maturity portfolio increased by $0.3 billion.
Table 7: Carrying value of investment securities at December 31.
For additional information on the securities portfolio, see Note 3 of Notes to Consolidated Financial Statements included elsewhere in this Report.
Table 8: Loan portfolio composition at December 31.
Total loans increased 5.2% during 2006, with commercial loans and commercial real estate loans increasing 17.7% and 5.3%, respectively, from the previous year end. Consumer loans also increased by 15.7%, while the residential mortgage portfolio declined by 8.4%. The FIRSTFED and First City acquisitions completed by Webster during 2004 contributed to the overall increase from year end 2003.
Table 9: Contractual maturities and interest-rate sensitivity of selected loan categories at December 31, 2006.
The contractual maturities are expected gross receipts from borrowers and do not reflect premiums, discounts and deferred costs.
Asset quality improved slightly in 2006 as nonperforming assets decreased to $61.8 million at December 31, 2006 compared to $66.3 million a year earlier. The decrease in nonperforming assets was primarily the result of decreases in nonperforming commercial and commercial real estate loans and commercial other real estate owned. Total commercial and commercial real estate nonperforming assets decreased $13.6 million when compared to the balances at December 31, 2005. Partially offsetting these decreases were increases of $9.1 million in residential and consumer nonperforming assets. The allowance for loan losses increased in 2006 to $147.7 million from $146.5 million in 2005 due to the $4.7 million allowance for loan losses acquired as part of the acquisition of NewMil, partially offset by the effect of net charge-offs exceeding the provision for losses during the year.
Nonperforming assets, loan delinquency and credit losses are considered to be key measures of asset quality. Asset quality is one of the key factors in the determination of the level of the allowance for credit losses. See Allowance for Credit Losses contained elsewhere within this section for further information on the allowance.
Management devotes significant attention to maintaining asset quality through conservative underwriting standards, active servicing of loans and aggressive management of nonperforming assets. Nonperforming assets include nonaccruing loans and foreclosed properties. The aggregate amount of nonperforming assets decreased as a percentage of total assets to 0.36% at December 31, 2006 from 0.37% at December 31, 2005.
Nonperforming loans were $58.9 million at December 31, 2006, compared to $60.6 million at December 31, 2005. Nonperforming loans are defined as nonaccruing loans. The ratio of nonperforming loans to total loans was 0.46% and 0.49% at December 31, 2006 and 2005, respectively. The allowance for loan losses at December 31, 2006 was $147.7 million and represented 250.7% of nonperforming loans and 1.14% of total loans. At December 31, 2005, the allowance was $146.5 million and represented 241.9% of nonperforming loans and 1.19% of total loans. Interest on nonaccrual loans that would have been recorded as additional interest income for the years ended December 31, 2006, 2005 and 2004 had the loans been current in accordance with their original terms approximated $2.0 million,
$3.2 million and $2.1 million, respectively. See Note 1 of Notes to Consolidated Financial Statements contained elsewhere within the Report for information concerning the nonaccrual loan policy.
Total nonperforming loans decreased $1.6 million, or 2.7% in 2006. This decrease was primarily the result of a $5.3 million decrease in commercial loans and a $5.1 million decrease in commercial real estate loans, partially offset by an $8.8 million increase in residential and consumer loans. The increase in residential and consumer loans was principally due to the acquisition of $0.9 million of nonperforming assets from NewMil; a $3.4 million increase in residential mortgages to borrowers primarily within the Webster footprint; and a $4.4 million increase in home equity accounts that are associated with the expansion of Websters national distribution channels. Nonperforming asset levels at December 31, 2006 compare favorably to Websters ten year averages for nonperforming residential and consumer assets. The new nonperforming loans do not represent a concentration in any particular borrower group or collateral type.
Table 10: Nonperforming assets.
It is Websters policy that all commercial loans 90 or more days past due are placed in nonaccruing status. There are, on occasion, circumstances that cause loans to be placed in the 90 days and accruing category, for example, loans that are considered to be well secured and in the process of collection. Loans past due 90 days or more and still accruing are disclosed in Table 12 below.
Table 11: Troubled debt restructures.
The following accruing loans are considered troubled debt restructurings. A modification of terms constitutes a troubled debt restructuring if, for reasons related to the debtors financial difficulties, a concession is granted to the debtor that would not otherwise be considered.
Table 12: Loans past due 30 days or more.
The following table sets forth information regarding Websters delinquent loan and lease portfolio, excluding loans held for sale and nonaccrual loans and leases, at December 31.
The allowance for credit losses, which comprises the allowance for loan losses and the reserve for unfunded credit commitments, is maintained at a level estimated by management to provide adequately for probable losses inherent in the 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 managements judgment, deserve current recognition in estimating loan losses. In assessing the specific risks inherent in the portfolio, management takes into consideration the risk of loss on nonaccrual loans, criticized loans and watch list loans including an analysis of the collateral for such loans. Management believes that the allowance for credit losses at December 31, 2006 is adequate to cover probable losses inherent in the loan portfolio and unfunded commitments at the balance sheet date.
Management considers the adequacy of the allowance for credit losses a critical accounting policy. As such, the adequacy of the allowance for credit losses is subject to judgment in its determination. Actual loan losses could differ materially from managements estimate if actual loss factors and conditions differ significantly from the assumptions utilized. These factors and conditions include the general economic conditions within Websters 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 December 31, 2006, actual results may prove different and these differences could be significant.
Websters Loan Loss Allowance Committee meets on a quarterly basis to review and conclude on the adequacy of the allowance. In addition, findings from the loan review function are reported to the Audit Committee on a quarterly basis.
Websters methodology for assessing the appropriateness of the allowance consists of several key elements. The loan portfolio is segmented into pools of loans that are similar in type and risk characteristic. These homogeneous pools are tracked over time and historic delinquency, nonaccrual and loss information is collected and analyzed. In addition, problem loans are identified and analyzed individually on an ongoing basis to detect specific probable losses. Webster collects industry delinquency, nonaccrual and loss data for the same portfolio segments for comparison purposes.
The data is analyzed and estimates of probable losses in the portfolio are estimated by calculating formula allowances for homogeneous pools of loans and classified loans and specific allowances for impaired loans. The formula allowance is calculated by applying loss factors to the loan pools based on historic default and loss rates, internal risk ratings, and other risk-based characteristics. Changes in risk ratings, and other risk factors, from period to period for both performing and nonperforming loans affect the calculation of the formula allowance. Loss factors are based on Websters loss experience, and may be adjusted for significant conditions that, in managements judgment, affect the collectability of the portfolio as of the evaluation date. The following is considered when determining probable losses:
At December 31, 2006, the allowance for loan losses was $147.7 million, or 1.14% of the total loan portfolio, and 250.7% of total nonperforming loans. This compares with an allowance of $146.5 million or 1.19% of the total loan portfolio, and 241.9% of total nonperforming loans at December 31, 2005. The allowance for loan losses does not include the reserve for unfunded credit commitments that is discussed in the following paragraph.
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 December 31, 2006, the reserve for unfunded credit commitments was $7.3 million, which represents 4.7% of the total allowance for credit losses. This reserve was established as a separate component of the allowance for credit losses in the fourth quarter of 2005, at which time the reserve was $9.1 million or 5.9% of the total allowance for credit losses.
The allowance for credit losses incorporates the range of probable outcomes as part of the loss estimate calculation, as well as an estimate of loss representing inherent risk not captured in quantitative modeling and methodologies. These factors include, but are not limited to, imprecision in loss estimate methodologies and models, internal asset quality trends, changes in portfolio characteristics and loan mix, significant volatility in historic loss experience, and the uncertainty associated with industry trends, economic uncertainties and other external factors.
Table 13: Allowance for credit losses activity.
Table 14: Net charge-offs to average outstanding loans by category.
Table 15: Allocation of allowance for credit losses.