Webster Financial 10-K 2008
Documents found in this filing:
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, 2007
Commission File Number: 001-31486
WEBSTER FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Webster Plaza, Waterbury, Connecticut 06702
(Address and zip code of principal executive offices)
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 x No ¨.
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 ¨ No x.
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 x No ¨.
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. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12B-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12B-2) Yes ¨ No x.
The aggregate market value of the common stock held by non-affiliates of Webster Financial Corporation was approximately $2.2 billion, based on the closing sale price of Common Stock on the New York Stock Exchange on June 30, 2007, the last trading day of the registrants most recently completed second quarter.
The number of shares of common stock outstanding, as of January 31, 2008: 52,480,182.
DOCUMENTS INCORPORATED BY REFERENCE
Part III: Portions of the Definitive Proxy Statement for the Annual Meeting of Shareholders to be held on April 24, 2008.
WEBSTER FINANCIAL CORPORATION
2007 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, 2007 had assets of $17.2 billion and shareholders equity of $1.7 billion. Websters principal assets at December 31, 2007 were all of the outstanding capital stock of Webster Bank, National Association (Webster Bank), and Webster Insurance, Inc. (Webster Insurance). Subsequent to December 31, 2007, Webster sold Webster Insurance. See Note 2 of Notes to Consolidated Financial Statements contained elsewhere within this report for additional information.
Webster, through Webster Bank and various non-banking financial services subsidiaries, delivers financial services to individuals, families and businesses throughout southern New England and eastern New York State. Webster also offers equipment financing, commercial real estate lending, asset-based lending, and insurance premium financing on a regional or national basis. Webster Bank provides commercial banking, retail banking, consumer financing, mortgage banking, trust and investment services through 181 banking offices, 343 ATMs and its Internet website (www.websteronline.com). Through its HSA Bank division (www.hsabank.com), Webster Bank offers health savings accounts on a nationwide basis. Websters common stock is traded on the New York Stock Exchange under the symbol WBS.
Websters mission statement, the foundation of our operating principles, is 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. Operating objectives include acquiring and developing customer relationships through marketing, on boarding and cross-sale efforts to fuel internal growth and expanding geographically in contiguous markets through a build and buy strategy. Webster also pursues acquisitions of like minded partners who share Websters vision to be New Englands bank.
Webster facilitates cooperation across 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 that meet regularly to share opportunities and call jointly on customers and prospects. This group works together to develop deeper customer relationships through the cross-sell of products in and across lines of business.
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 wealth management and retail operations. Asset-based lending is located primarily in the Northeast with a national presence. Our well diversified commercial lending portfolio, which grew 4.5% to $4.5 billion at December 31, 2007, compared to $4.3 billion at December 31, 2006, 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 was $1.5 billion at December 31, 2007, a decrease of 6.3%, compared to $1.6 billion at December 31, 2006, primarily due to prepayment volume.
Commercial Real Estate Lending
The Commercial Real Estate Division provides variable rate and fixed rate financing alternatives (primarily in Connecticut, Massachusetts, Rhode Island, New York, New Jersey and Pennsylvania) 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 and industrial and office properties. Loan types include construction, construction mini-perm and permanent loans, in amounts that range primarily 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 was $2.1 billion at December 31, 2007, an increase of 8.1%, compared to $1.9 billion at December 31, 2006.
Webster Business Credit Corporation (WBCC) is Webster Banks asset-based lending subsidiary with headquarters in New York, New York and eight regional offices. 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 was $793 million at December 31, 2007, an increase of 3.5%, compared to $766 million at December 31, 2006.
Deposit and Cash Management Services
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 online banking system Webster Web-Link (tm) which uses image technology to provide online information to our clients.
Retail Banking is dedicated to serving the needs for over 430,000 consumer households and approximately 60,000 small business customers in southern New England and eastern New York State. Websters Retail Banking segment is focused on growing its customer base through the acquisition of new customer relationships and the retention and expansion of existing 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 181 banking offices and 343 ATMs in Connecticut, Massachusetts, Rhode Island and New York. In the fourth quarter of 2007, Webster announced an ATM branding agreement with plans for 158 in-store Webster branded ATMs in select Walgreens stores in Massachusetts (131 locations, primarily in the eastern part of the state), Rhode Island (20 locations) and Connecticut (7 locations). The project is scheduled to be implemented in the first quarter of 2008. This branding agreement complements Websters branch expansion program and establishes another distribution platform for future growth in Rhode Island and the Boston market. The distribution network also includes a telephone banking center and a full-range
of internet banking services. In addition to transaction and servicing convenience, Retail Bankings distribution network delivers a full range of deposit, lending and investment products and services to both consumer and small business customers within Websters regional footprint.
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, 2007, retail deposits within the branch footprint totaled $9.9 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.
Small Business Activities
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 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 and the B&P lending effort is focused on those customers with borrowing needs from $25,000 to $2 million. Webster was recognized in 2007, for the fifth consecutive year, by the Connecticut district of the Small Business Administration (SBA) as the states leading bank SBA 504 lender and was awarded the national Excellence in Lending Award by the SBA.
Beginning in February 2007, Webster commenced offering the investment and securities-related services, including brokerage and investment advice that it had previously offered through its subsidiary Webster Investment Services, Inc. (WIS) through a strategic partnership with UVEST Financial Services Group, Inc. UVEST, a provider of investment and insurance programs in financial institutions branches, is a broker dealer registered with the Securities and Exchange Commission, a registered investment advisor under federal and applicable state laws, a member of the Financial Industry Regulatory Authority (FINRA), and a member of the Securities Investor Protection Corporation (SIPC). Webster, through its relationship with UVEST, has over 100 dual employees who are registered representatives located throughout its branch network offering customers an array of insurance and investment products including stocks and bonds, mutual funds, annuities and managed accounts. Brokerage and online investing services are available for customers. At December 31, 2007, Webster had $1.9 billion of assets under administration in its strategic partnership with UVEST, compared with $1.6 billion of assets under administration at WIS at December 31, 2006. These assets are not included in the Consolidated Financial Statements.
De novo Expansion and Acquisition
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. Four branches were opened during 2007 with new locations added in Connecticut, Massachusetts and New York. Through the de novo branch expansion program, a total of 29 de novo branches have been opened since 2002, adding a total of $781 million in deposits through December 31, 2007.
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. Webster Banks
loan distribution channels consist of the branch network, loan officers, the call center and third party licensed mortgage brokers. Additionally, loan products may be offered through direct mail programs. The division also provides the convenience of the Internet for home equity lines and loans applications that are available in the states where Webster applies its focus.
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, 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. FICO scores and collateral values are re-evaluated on a quarterly basis.
In late 2007, Webster discontinued its indirect residential construction lending and its indirect home equity lending outside of its primary New England market area referred to as National Wholesale Lending. In the aggregate, these two indirect out of footprint loan portfolios totaled $424.0 million ($340.7 million of indirect home equity loans and $83.3 million of residential construction loans), have been placed into liquidating portfolios, and will be managed by a designated credit team.
Residential Mortgages and Mortgage Banking
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. The Companys primary lending markets are Connecticut, southern New England and the mid-Atlantic region. Webster offers 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.
Total residential mortgage originations for the group were $3.2 billion in 2007 compared to $3.0 billion in 2006. Originations included mortgages originated from a national wholesale channel. Webster discontinued all national wholesale mortgage banking activities and, as a result, has closed its wholesale lending offices in Seattle, Washington; Phoenix, Arizona; Cheshire, Connecticut; and Chicago, Illinois. Webster recorded severance and other costs, primarily for lease terminations and outplacement, of $3.5 million (pre tax) in the fourth quarter of 2007 related to the discontinuance of national wholesale mortgage banking activities. Websters remaining mortgage and consumer lending operations in Cheshire, Connecticut will now focus solely on direct to consumer retail originations.
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 continuing loan portfolio remained flat year over year with a total continuing portfolio balance of $2.9 billion at both December 31, 2007 and 2006. The liquidating consumer loan portfolio was $340.7 million at December 31, 2007.
Health Savings Accounts
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 (www.hsabank.com) and telephone service. As of December 31, 2007, HSA Bank had approximately 187,000 accounts compared to approximately 155,000 accounts at December 31, 2006. HSA deposit balances totaled $403.9 million at December 31, 2007, an increase of 40.9%, compared to $286.6 million at December 31, 2006.
Websters Government Finance Group provides a full range of banking, cash management, investment, and credit-related services to public entities across Websters four-state footprint. The group offers customized products that are delivered locally through single points of contact through our offices located in Connecticut and Massachusetts. By acquiring and developing relationships that consider Webster to be their primary bank, the Group has become a reliable source of funding for the Bank. This business effort has been enhanced by the significant investment the Bank has made in recent years in both the depth and breadth of cash management services and overall infrastructure. Government Finance group deposits were $965.7 million at December 31, 2007, an increase of 52.0%, compared to $635.2 million December 31, 2006.
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 was $985.3 million at December 31, 2007, an increase of 10.7% compared to $889.8 million at December 31, 2006.
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 2007, financing initiatives encompassed four distinct industry/equipment niches, each operating as a division: Construction and Transportation, Environmental, Manufacturing and General Aviation.
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 all cases, financing terms are for less than financed equipments projected 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.
Webster Financial Advisors (WFA) targets high net worth clients, not-for-profit organizations and business clients with investment management, trust, credit and deposit products and financial planning services. WFA takes a comprehensive view when dealing with clients in order to fully serve their short and long-term financial objectives. Proprietary and non-proprietary investment products are offered through WFA and the J. Bush & Co. division. WFA provides several different levels of financial planning expertise including specialized services through another wholly-owned subsidiary, Fleming, Perry & Cox. At both December 31, 2007 and 2006, there were approximately $2.3 billion of client assets under management and administration of which $1.5 billion were under management, respectively. These assets are not included in the Consolidated Financial Statements.
Insurance Premium Financing
Budget Installment Corp. (BIC), an insurance premium financing subsidiary headquartered in Garden City, 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 was $84.4 million at December 31, 2007, a decrease of 6.3%, compared to $90.1 million at December 31, 2006.
Risk Management Functions
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 by the Chief Credit Risk Officer to the Credit Risk Management Committee, which Webster established in 2007 as one of the outcomes of the Companys organization review, and to the Board of Directors regarding the credit quality of the loan portfolio.
Recognizing the growing importance of operational risk as a unique discipline, in 2007 Webster established a separate and distinct unit to focus on issues of operational risk. An Operational Risk Management Committee was established to oversee the management and effectiveness of Websters operational risk framework. The Committee includes the Corporate Compliance Department, Internal Audit, Enterprise Risk Management and Corporate Security.
Strategic and Organizational Reviews
The Company completed its previously announced strategic and organizational reviews in 2007. The goal of the strategic review was to look at Webster and all lines of business and focus on core competencies, identify operational efficiencies, and position Webster to realize its vision of becoming New Englands bank. This required evaluating the contribution, growth potential, fit and alignment of each segment and line of business with the Companys goals and mission. In the first quarter of 2007, the Company announced a decision to close Peoples Mortgage Company; terminate mezzanine lending operations (Webster Growth Capital); discontinue indirect residential construction lending outside of its primary New England market area (National Construction Lending); evaluate a restructuring or sale of its insurance operations; and outsource the back office operations of Webster Investment Services.
Additional outcomes of the strategic review that the Company announced in 2007 included:
Webster also has launched an earnings optimization program that began in January 2008, assigning senior officers from each line of business and shared services area to teams dedicated to enhance revenues and reduce expenses. Harvest Earnings Group, LLC, a highly regarded firm with expertise in this area, is assisting with this employee-led program. The effort to improve operating efficiency will be undertaken in the first half of 2008 and implemented through the end of the year and into 2009. The Company anticipates that some job eliminations will occur as a result of this initiative.
In addition, the Company announced its intent to open new branch locations in Greenwich, Connecticut and North Kingston, Rhode Island and a downtown Boston flagship branch by the end of 2008. Four new branches (New Rochelle, New York; Longmeadow, Massachusetts; East Longmeadow, Massachusetts; and Woodbridge, Connecticut) were opened during the third and fourth quarters of 2007. The Company intends to optimize its existing franchise by combining certain offices into stronger locations and using efficiency gained to fund investment in de novo branches. The Company has also detailed a facilities strategy to consolidate back office operations into one location and a regional hub approach to consolidate facilities in certain cities, which is expected to occur over the next two years.
The stated goal of the organizational review, was to implement a structure that will result in a more efficient and effective organization. The organizational review resulted in the creation of the Office of the Chairman, which
consists of the CEO, COO, and CFO; an Executive Management Committee; a new position the Chief Administrative Officer, who is responsible for all shared services functions; restructuring and streamlining of governance committees and layers of management; and a restructured approach to risk management that distinctly addresses credit, operating and interest rate risk.
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. No acquisitions were completed during 2007.
Websters direct subsidiaries as of December 31, 2007, included 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 IV, Webster Statutory Trust I, Peoples Bancshares Capital Trust II, Eastern Wisconsin Bancshares Capital Trust II and NewMil Statutory Trust I. See Note 13 of Notes to Consolidated Financial Statements for additional information.
Webster Banks direct subsidiaries include Webster Mortgage Investment Corporation, Webster Preferred Capital Corporation, Webster Business Credit Corporation, Budget Installment Corporation and Center Capital Corporation. Webster Bank is the primary source of retail activity within the consolidated group. Webster Bank provides banking services through 181 banking offices, 343 ATMs and the Internet. Residential mortgage origination activity is conducted through Webster Bank. 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. Various commercial lending products are provided through Webster Bank and its subsidiaries 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 for end users of equipment. Additionally, Webster Bank has various other subsidiaries that are not significant to the consolidated entity.
At December 31, 2007, Webster had 3,354 full-time equivalent employees including 3,213 full time and 396 part-time and other employees. 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 20 of Notes to Consolidated Financial Statements contained elsewhere within this 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 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%. Under the capital adequacy guidelines a bank holding company or insured depository institution is generally deemed well capitalized if its leverage ratio is greater than 5%, its Tier 1 capital to risk-weighted assets is greater than 6%, and its total capital to risk-weighted assets is greater than 10%. At December 31, 2007, 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. If a financial holding companys subsidiary insured depository institutions fail 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 companys subsidiary insured depository institutions fail 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, 2007, Webster Bank was in compliance with all minimum capital requirements and was well capitalized under the capital guidelines. 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 declared do not exceed net profits for the current year to date as of the declaration date plus net retained profits from the preceding two years less dividends declared in such years. At December 31, 2007, Webster Bank was in compliance with all applicable minimum capital requirements and had no dividend paying capacity to pay dividends to Webster. 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. 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 these trust and related fiduciary services to its customers through Webster Financial Advisors, a division of Webster Bank. In 2007, the Federal Reserve and Securities and Exchange Commission (SEC) issued a final joint rulemaking to clarify that traditional banking activities involving some elements of securities brokerage activities, such as most trust and fiduciary activities, may continue to be performed by banks rather than being pushed-out to affiliates supervised by the SEC. Fleming, Perry & Cox, Inc. (Fleming) is a registered investment advisor and as such is subject to regulation, supervision, and examination by the SEC. Webster Bank is authorized to engage as an underwriter of municipal securities and as such is subject to regulation by the Municipal Securities Rulemaking Board.
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 there under. 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.
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 the 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 the 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 in 2002 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 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 corporate governance rules, and the SEC and securities exchanges have adopted extensive additional disclosure, corporate governance and other related rules pursuant to its mandate. 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.
During 2007, the Federal Reserve, OCC and other federal financial regulatory agencies issued final guidance on subprime mortgage lending to address issues relating to certain subprime mortgages, especially adjustable-rate mortgage (ARM) products that can cause payment shock. The subprime guidance described the prudent safety and soundness and consumer protection standards that the regulators expect banks and financial institutions, such as Webster and Webster Bank, to follow to ensure borrowers obtain loans they can afford to repay.
In December 2006, the Federal Reserve, OCC and other federal financial regulatory agencies issued similar final guidance on sound risk management practices for concentrations in commercial real estate (CRE) lending. The
CRE guidance provided supervisory criteria, including numerical indicators to direct examiners in identifying institutions with potentially significant CRE loan concentrations that may warrant greater supervisory scrutiny. The CRE criteria do not constitute limits on CRE lending, but the CRE guidance does provide certain additional expectations, such as enhanced risk management practices and levels of capital, for banks with concentrations in CRE lending. Management believes it has in place the risk management practices and capital levels commensurate with the level of CRE lending.
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. In 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 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 was used in part to offset its 2007 deposit insurance assessment and the balance is expected to offset up to 90% of its 2008 assessment. As of December 31, 2007, the credit balance remaining was $6.5 million, which Webster anticipates being fully utilized in 2008. Webster will be subject to an increased deposit premium expense after fully utilizing the credit which is anticipated to be during the fourth quarter of 2008.
In addition, all FDIC insured institutions are required to pay assessments to the FDIC at an annual rate of approximately 0.0114% of insured deposits to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. These assessments will continue until the Financing Corporation bonds mature in 2017 through 2019.
Under the Federal Deposit Insurance Act, the FDIC may terminate the insurance of an institutions deposits upon a finding that the institution has engaged in unsafe or unsound practices, rule, order or condition imposed by the FDIC. Websters management does not know of any practice, condition or violation that might lead to termination of deposit insurance.
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.
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 the SECs Securities Act Industry 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.
In recent years, Webster has focused, in part, on growth through acquisitions. 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 Results Of Operations Are Affected By Economic Conditions Locally And Nationally.
Decreases in real estate values could adversely affect the value of property used as collateral for our loans. No assurance can be given that the original appraised values are reflective of current market conditions. Adverse changes in the economy caused by inflation, recession, unemployment or other factors beyond our control may also have a negative effect on the ability of our borrowers to make timely loan payments, which would have an adverse impact on our earnings. Consequently, deterioration in economic conditions, particularly in Connecticut, could have a material adverse impact on the quality of our loan portfolio, which could result in an increase in delinquencies, causing a decrease in our interest income as well as an adverse impact on our loan loss experience, causing an increase in our allowance for loan losses. Such deterioration could also adversely impact the demand for our products and services, and, accordingly, our results of operation.
The second half of 2007 was highlighted by significant disruption and volatility in the financial and capital marketplaces. This turbulence has been attributable to a variety of factors, including the fallout associated with the subprime mortgage market. One aspect of this fallout has been significant deterioration in the activity of the secondary residential mortgage market. The disruptions have been exacerbated by the continued decline of the real estate and housing market along with significant mortgage loan related losses incurred by many lending institutions. In addition, the significant decline in economic growth, nationally, during the fourth quarter of 2007 has led to a national economy bordering on recession. Webster is not immune to negative consequences arising from overall economic weakness and, in particular, a sharp downturn in the housing industry locally and nationally. During the second half of 2007, we have experienced an increase in non-performing loans and net loan charge-offs. No assurance can be given that these conditions will improve or will not worsen or that such conditions will not result in a further increase in delinquencies, causing a decrease in our interest income, or continue to have an adverse impact on our loan loss experience, causing an increase in our allowance for credit losses.
The Company Operates In A Highly Competitive Industry And Market Area
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 than Webster, as well as better pricing for those products and services.
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 and 2007, Webster securitized a total of approximately $1.0 billion and sold $250 million of its residential mortgage loans. Residential mortgages were $3.6 billion at the end of 2007, a decrease of 18.2%, compared to $4.46 billion at December 31, 2006. At the end of 2007, commercial loans were $5.6 billion, including (1) commercial and industrial loans at $3.5 billion, up 3.8% compared to balances at December 31, 2006, and (2) commercial real estate loans at $2.1 billion, up 8.1% compared to balances at December 31, 2006. Consumer loans in the continuing consumer loan portfolio, primarily home equity loans and lines, remained flat year over year with a total continuing portfolio balance of $2.9 billion at both December 31, 2007 and 2006. Commercial, commercial real estate and consumer loans comprised 70.8% of total loans at December 31, 2007 compared to 65.8% at December 31, 2006. 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.
Websters Allowance For Credit Losses May Be Insufficient
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 this 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.
Decreases in interest rates might cause depositors to seek higher yielding products including locking into longer term higher yielding certificates of deposits, if available. If the cost of interest-bearing deposits does not decrease as fast as comparable term borrowings, the net interest income will be negatively affected. Changes in the asset and liability mix may also affect the net interest income.
Webster Is Subject To Extensive Government Regulation And Supervision
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.
Websters Controls And Procedures May Fail Or Be Circumvented
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.
New Lines Of Business Or New Products And Services May Subject Webster To Additional Risks
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.
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
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 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 15 of Notes to Consolidated Financial Statements contained elsewhere within this report for further information on such dividend restrictions.
Webster May Not Be Able To Attract And Retain Skilled People
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.
Websters Information Systems May Experience An Interruption Or Breach In Security
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.
Webster Continually Encounters Technological Change
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 actions 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, 2007, Webster Bank had 181 banking offices located in Connecticut, Massachusetts, Rhode Island and New York as follows:
Lease expiration dates range from 1 to 80 years with renewal options of 2 to 35 years. Additionally, Webster Financial Advisors, headquartered in Stamford, Connecticut, has offices in Hartford, New Haven, Waterbury and Providence, Rhode Island and HSA Bank is headquartered in Sheboygan, Wisconsin.
Subsidiaries maintain the following offices at December 31, 2007: Webster Insurance was headquartered in Meriden, Connecticut and had offices in several Connecticut communities, including Vernon, Waterford and Westport as well as an office in Harrison, New York. On February 1, 2008, Webster sold Webster Insurance. See Note 2 of Notes to Consolidated Financial Statements contained elsewhere within this report for additional information. 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; Carlsbad, California; Blue Bell and Cranberry Township, Pennsylvania; and Schaumburg, Illinois. WBCC is headquartered in New York, New York with offices in Atlanta, Georgia; South Easton, Massachusetts; Chicago, Illinois; Cleveland, Ohio; Plano, Texas; Charlotte, North Carolina; Memphis, Tennessee; and Hartford, Connecticut. BIC is headquartered in Garden City, New York.
The total net book value of properties and equipment owned at December 31, 2007 was $193.1 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 2007, 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 2007 and 2006 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, 2008, the closing market price of Webster common stock was $33.87. Webster increased its quarterly dividend to $0.30 per share in the second quarter of 2007.
Common Stock (per share)
Webster had 10,152 holders of record of common stock and 52,480,182 shares outstanding on January 31, 2008. 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 declared do not exceed its net profits for the current year to the date of declaration plus net retained profits from the preceding two years less dividends declared in such years. At December 31, 2007, Webster Bank was in compliance with all applicable minimum capital requirements and had no dividend paying capacity to pay dividends to Webster.
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 this report for additional information on dividends.
Recent Sale of Unregistered Securities; Use of Proceeds from Registered Securities
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.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
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, 2007. Management may engage in future share repurchases as liquidity conditions permit and market conditions warrant.
Stock-Based Compensation Plans
Information regarding stock-based compensation awards outstanding and available for future grants as of December 31, 2007, represents stock-based compensation plans approved by shareholders and is presented in the table below. There are no plans that have not been approved by shareholders. Additional information is presented in Note 21, 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, 2002.
The following discussion should be read in conjunction with the Consolidated Financial Statements of Webster Financial Corporation and the Notes thereto included elsewhere in this report (collectively, the Financial Statements).
Critical Accounting Policies and Estimates
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:
Allowance for Credit Losses
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.
Valuation of Goodwill/Other Intangible Assets and Analysis for Impairment
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, discounted cash flows, 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 generally represent items that will require a future tax payment, for which tax expense has been recognized in the Companys financial statements and 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.
Pension and Other Postretirement Benefits
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 20 of Notes to Consolidated Financial Statements for further information.
Results of Operations
Websters net income was $96.8 million or $1.76 per diluted share in 2007, compared to $133.8 million or $2.47 per diluted share in 2006, a decrease of 27.7%. Income from continuing operations was $110.7 million or $2.01 per diluted share in 2007, compared to $133.7 million or $2.47 per diluted share in 2006, a decrease of 17.2%.
During the fourth quarter, management determined that the sale of its insurance agency business (Webster Insurance) would be structured such that the consideration would comprise an upfront payment and additional potential consideration over a multi-year earn-out period. Given this structure, Webster accordingly wrote down the carrying value of its investment and as of year end 2007 reported Webster Insurance separately from its continuing operations. The results of Webster Insurance (and the loss on write-down of the assets held for disposition to fair value) are shown as discontinued operations, net of tax in the Consolidated Statements of Income. Webster has reported the assets and liabilities of Webster Insurance as assets and liabilities held for disposition at both December 31, 2007 and 2006.
Results from continuing operations include an increase in provisions for credit losses of $56.8 million, severance and other charges of $15.6 million, a net charge of $6.8 million related to the redemption of debt and a $3.6 million loss on the write-down of direct investments to fair value. The net impact of these items was $82.8 million ($53.8 million after tax or $0.98 per diluted share). Results from continuing operations in 2006 include charges of $57.0 million ($37.0 million after tax or $0.69 per diluted share) related to the balance sheet repositioning actions taken in 2006.
The net interest margin for 2007 increased by 24 basis points when compared to the prior year. This was primarily due to increases in higher yielding commercial and consumer loans and a decrease in average outstanding securities and borrowings partially offset by an increase in the cost of deposits. Average interest bearing liabilities decreased $1.2 billion, or 7.3%, with decreases in borrowings of $1.5 billion partially offset by increases in average deposits of $0.4 billion. Average earning assets decreased $1.1 billion, or 6.6%, ($409.9 million in loans and $704.8 million in securities) when compared to 2006 as a result of the balance sheet restructuring actions.
Non-interest income of $202.3 million increased by $70.7 million, or 53.7%, in 2007 compared to 2006. The increase in non-interest income was primarily due to the $48.9 million and $2.3 million in losses recognized to
write-down and subsequently sell, respectively, the available for sale mortgage-backed securities portfolio in 2006, the $5.7 million loss on the sale of mortgage loans in 2006 and an increase in deposit service fees of $17.9 million in 2007 compared to 2006 partially offset by a $3.6 million decrease in loan related fees.
Non-interest expenses of $484.0 million increased $47.6 million, or 10.9%, compared to 2006. The increase reflects the impact of severance and other costs of $15.6 million, debt prepayment expenses of $8.9 million and an increase in compensation and benefits of $15.0 million, $3.4 million related to the write-off of software development costs and $2.3 million of closing costs related to Peoples Mortgage Corporation (PMC).
Selected financial highlights are presented in the following table.
Table 1: Three-year average balance sheet and net interest margin. Average balances are daily averages and yields are calculated on a tax equivalent basis.
Net Interest Income
Net interest income which is the difference between interest earned on loans, investments and other interest-earning assets and interest paid on deposits and borrowings, totaled $508.2 million in 2007, compared to $508.6 million in 2006, a decrease of $0.4 million. 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. The decrease in net interest income is largely due to lower volumes of average interest-earning assets, mostly related to decreases in average securities partially offset by decreases in average interest-bearing liabilities related to decreases in average borrowings.
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 (not presented on a tax-equivalent basis).
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 2005 at 5.25%, and 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%. During 2007, the prime interest rate decreased 50 basis points in each of the last two quarters to end the year at 7.25%. The federal funds rate, which is the cost of immediately available overnight funds, fluctuated in a similar manner. It began 2005 at 2.25%, 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%. During 2007, the federal funds rate decreased 50 basis points in each of the last two quarters to end the year at 4.25%. Because the decreases in the prime interest rate and the federal funds rate occurred at the end of both of the third and fourth quarters of 2007, the Companys net interest margin does not reflect the full impact of the rate decreases. Additionally, the balance sheet repositioning actions resulted in partially replacing lower earning residential loans with higher earning commercial and consumer loans.
Additional rate cuts were made in early 2008. In January of 2008 the Federal Reserve Board lowered the federal funds rate by 125 basis points to end the month at 3.00%. The prime rate was reduced by 125 basis points in January 2008 and closed at 6.00% at January 31, 2008.
Interest income (on a fully tax-equivalent basis) decreased $17.5 million, or 1.7%, to $1.0 billion for 2007 as compared to 2006. A decrease in the average interest earning-assets over the prior year was partially offset by slightly higher average yields earned on the assets. The decline in the volume of interest-earning assets is a result of the balance sheet repositioning which began in the fourth quarter of 2006 and was completed by the first quarter of 2007. The average loan portfolio, excluding loans held for sale, decreased by $409.9 million, or 3.2%, compared to 2006. Average securities decreased by $704.8 million, or 23.0%, compared to 2006. Additionally higher yielding commercial and consumer loans partially replaced reductions in residential loans.
The yield earned on interest-earning assets increased 35 basis points for the year ended December 31, 2007 to 6.60% compared to 6.25% for 2006 as a result of the balance sheet repositioning actions. The loan portfolio yield increased 17 basis points to 6.76% for the year ended December 31, 2007 and comprised 81.2% of average interest-earning assets compared to the loan portfolio yield of 6.59% and 78.3% of average interest-earning assets for the year ended December 31, 2006. Additionally, the yield on securities was 5.79%, an 86 basis point improvement over 2006.
Interest expense for the year ended December 31, 2007 decreased $18.8 million, or 3.7%, compared to 2006. The decrease was primarily due to a decline in the average total borrowings of $1.5 billion when compared to the average balance in 2006. This decrease in average borrowings was a result of the balance sheet repositioning actions taken.
The cost of interest-bearing liabilities was 3.28% for the year ended December 31, 2007, an increase of 12 basis points compared to 3.16% for 2006. Deposit costs for the year ended December 31, 2007 increased to 2.90% from 2.57% in 2006, an increase of 33 basis points. Total borrowing costs for the year ended December 31, 2007 increased 33 basis points to 5.34% from 5.01% for 2006. Since the reduction in the prime interest rate and the federal funds rate occurred at the end of the third and fourth quarters of 2007, the effects of the rate decreases are not fully reflected in the Companys net interest margin for 2007.
Provision for Credit Losses
The provision for credit losses was $67.8 million for the year ended December 31, 2007; an increase of $56.8 million compared to $11.0 million for the year ended December 31, 2006. The increase in the provision is primarily due to a $40.0 million provision recorded in the fourth quarter related to the liquidating portfolios of indirect out-of-market residential construction loans and indirect out-of-market home equity loans. Additionally, $11.0 million of the provision was recorded in the third quarter related to higher delinquency and non-accrual loans in the home equity portfolio. During 2007, total net charge-offs were $25.2 million compared to $16.4 million in 2006. See Tables 17 through 22 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, 2007, the allowance for credit losses totaled $197.6 million or 1.58% of total loans compared to $155.0 million or 1.20% at December 31, 2006. 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 2007 to 2006.
Excluding $54.6 million in losses on the write-down of mortgage-backed securities portfolio and the loss on sale of mortgage loans in 2006, the increase of $16.1 million, or 8.7%, in non-interest income over the prior year is primarily attributable to the increase in deposit service fees of $17.9 million and wealth and investment services of $2.0 million partially offset by a $3.6 million decrease in loan related fees. See below for further discussion of various components of non-interest income.
Deposit Service Fees. Deposit service fees increased $17.9 million, or 18.5%, compared to 2006. The increase was primarily due to increases in insufficient fund fees due to the implementation of a new tiered consumer fee structure during 2007, a change in the accounting for deposit losses, increased ATM surcharges and increased debit card usage.
Loan Related Fees. Loan related fees decreased by $3.6 million, or 10.3%, primarily due to a decrease in commercial real estate prepayment fees of $2.6 million.
Wealth and Investment Services. Wealth and investment service fees increased $2.0 million or 7.3% compared to 2006. The increase is due to an increase of $1.9 million in product sales volume and an increase of $0.1 million in trust services sales volume.
Table 4: Non-interest expense comparison of 2007 to 2006.
Total non-interest expenses for the year ended December 31, 2007 were $484.0 million, an increase of $47.6 million or 10.9% compared to December 31, 2006. Non-interest expense for the year ended December 31, 2007 increased primarily as a result of $15.6 million in severance and other, $15.0 million in compensation and benefits, $8.9 million in debt repayment expenses related to redemption premiums and unamortized issuance costs, $4.9 million in furniture and equipment expenses and $3.3 million in occupancy expenses. Partially offsetting the increase were decreases of $3.5 million in the amortization of intangible assets primarily due to core deposit intangibles from several past acquisitions becoming fully amortized during the year. Further changes in various components of non-interest expense are discussed below.
Compensation and Benefits. Total compensation and benefits increased by $15.0 million or 6.5% from 2006. The increase was primarily due to increases in compensation of $13.1 million and benefits of $1.9 million. The increase in compensation is attributed to merit increases, a full year of compensation related to the acquisition of NewMil, HSA Bank, compliance and regulatory areas, and a reduction in the deferral of salaries related to loan origination costs.
Occupancy. Total occupancy expense increased by $3.3 million or 7.2% compared to 2006. The increase in occupancy is primarily due to a full year of occupancy expense related to the acquisition of NewMil, expenses related to the de novo branch expansion program, higher rent expense and increased utilities.
Furniture and Equipment. Total furniture and equipment expense increased by $4.9 million or 9.0% compared to 2006. The increase is primarily due to higher depreciation on data processing equipment, increases in equipment maintenance contracts and service contract costs.
Severance and other costs. Charges totaling $15.6 million were recorded in 2007. Included in this charge was the discontinuation of the Companys national wholesale mortgage banking activities of $3.5 million, sale of PMC of $2.3 million, a retail office lease termination and a technology service contract settlement for $1.4 million and $1.5 million for the recording of a liability relating to Visa Inc. legal dispute settlements reflecting Websters share as a Visa U.S.A. member. If Visa Inc. is successful in completing its planned public offering, Webster expects that shares received from an anticipated Class B common stock redemption related to its ownership interest in Visa Inc. will more than offset the Visa U.S.A. related liability. See the following table for a breakout of the severance and other costs.
Table 5: Severance and Other Costs
At December 31, 2007, the remaining liability related to the closing of the Companys National Wholesale Operations was $3.4 million, the remaining liability related to the closing costs of Peoples Mortgage Company was $0.4 million and the remaining liability related to the other severance was $1.2 million.
Other Expenses. Other expenses increased $8.4 million, or 14.5%, compared to 2006 primarily due to increases in broker fees of $1.7 million and an increase in deposit losses and other miscellaneous expenses of $5.0 million.
The results of operations of Webster Insurance were reported as discontinued operations based on managements intent to exit the insurance agency business as of December 31, 2007. Loss from discontinued operations, net of tax, totaled $13.9 million for 2007 compared to income from discontinued operations of $0.1 million for 2006 and $2.7 million for 2005. The sale of Webster Insurance was completed on February 1, 2008. As part of the transaction Webster retained Webster Risk Services, a third-party workers compensation administrator of claims for which Webster is seeking a buyer. Webster Risk Services operations will be shown as discontinued operations in the future. See Note 2 of Notes to Consolidated Financial Statements contained elsewhere within this report for additional information.
Included in loss from discontinued operations for 2007 was a $14.0 million write-down to fair value charge related to the Companys anticipated sale of the insurance operations. The sale of Webster Insurance was structured such that the consideration comprised an upfront payment and additional potential consideration over a multi-year earn-out period.
Income tax expense decreased from the prior year principally due to a lower level of pre-tax income in 2007. The effective tax rate decreased to 30.3% in 2007 from 30.7% in 2006. The lower effective rate reflects the impact that higher levels of tax-exempt interest income and nontaxable increase in cash surrender value of life insurance had on the reduced pre-tax income offset by a significant increase in state and local tax expense in 2007 as compared to 2006.
Comparison of 2006 and 2005 Years
Net income for 2006 was $133.8 million, or $2.47 per diluted common share, a decrease of $51.4 million, or 27.8%, compared to net income of $185.2 million, or $3.42 per diluted common share for 2005. Net income from continuing operations for 2006 was $133.7 million or $2.47 per diluted common share, a decrease of $48.9 million or 26.8%, compared to net income from continuing operations of $182.5 million or $3.37 per diluted common share for 2005. Net interest income declined to $508.6 million for 2006, a decrease of $8.8 million, or 1.7%. The net interest margin for 2006 was 3.16%, down 13 basis points from 2005. Non-interest income was $131.6 million, a decrease of $44.9 million, or 25.4% compared to 2005 and non-interest expenses increased $19.6 million, or 4.7% compared to 2005.
Results from continuing operations 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 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 $44.9 million, or 25.4%, 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. 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 $19.6 million, or 4.7%, to $436.3 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.
Net Interest Income
Net interest income, which is the difference between interest earned on loans, investments and other interest-earning assets and interest paid on deposits and borrowings, totaled $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.
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.
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 4.93%, a 27 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 $870.1 million, or 7.3%, compared to 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.
Provision for Credit Losses
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,
total net charge-offs were $16.4 million compared to $3.2 million in 2005. See Tables 17 through 22 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, 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 6: Non-interest income comparison of 2006 to 2005.
The $44.9 million, or 25.4%, 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 $250.0 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 6.9% when compared to the prior year primarily 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 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.
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 7: Non-interest expense comparison of 2006 to 2005.
Total non-interest expenses for the year ended December 31, 2006 were $436.3 million, an increase of $19.6 million or 4.7% 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 $15.6 million or 7.3% 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. The acquisition of NewMil in the fourth quarter of 2006 also impacted the increase.
Occupancy. Total occupancy expense increased by $5.5 million or 13.6% 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 $5.7 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 2005. 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.
Business Segment Results
Websters operations are divided into three primary businesses that represent its core businesses, Commercial Banking, Retail Banking and Consumer Finance. The balance of Websters operating activities is reflected in Other. During 2007, Webster modified certain segment disclosures to reflect organizational and structural changes that were implemented in 2007. These financial disclosure modifications are reflected in this report and the financial information for prior periods has been revised to reflect the changes as if they had been in effect throughout all periods presented. See Note 22 of Notes to Consolidated Financial Statements contained elsewhere within this report for further information.
Table 8: Business Segment Performance Summary for the years ended December 31,
Webster uses an internal profitability reporting system to generate information by operating segment, which is based on a series of management estimates and allocations regarding funds transfer pricing, the provision for credit losses, non-interest expense and income taxes. These estimates and allocations, certain of which are subjective in nature, are continually being reviewed and refined. Changes in estimates and allocations that affect the reported results of any operating segment do not affect the consolidated financial position or results of operations of Webster as a whole.
The Company uses a matched maturity funding concept, also known as coterminous funds transfer pricing (FTP), to allocate interest income and interest expense to each business while also transferring the primary interest rate risk exposures to the Treasury group which is reflected in Other. The allocation process considers the specific interest rate risk and liquidity risk of financial instruments and other assets and liabilities in each line of business. The matched maturity funding concept basically considers the origination date and the earlier of the maturity date or the repricing date of a financial instrument to assign an FTP rates for loans and deposits originated each day. Loans are assigned an FTP rate for funds used and deposits are assigned an FTP rate for funds provided. From a governance perspective, this process is executed by the Companys Financial Planning and Analysis division and the process is overseen by the Companys Asset-Liability Committee.
The Company allocates the provision for credit losses (PCL) based upon expected loss (EL). EL differs from the PCL in that EL is a management tool based on the expected loss over the expected life cycle of a financial instrument, whereas the PCL is determined in accordance with U.S. generally accepted accounting principles (the PCL is the amount necessary to maintain the allowance for loan losses at a level reflecting the probable credit losses inherent in the loan portfolio at a point in time). EL is estimated using assumptions for exposure, probability of default (PD) and loss given default (LGD) for various credit products, risk ratings, collateral and industries. Exposure is the sum of the outstanding balance plus assumptions regarding additional potential draw-downs based on outstanding commitments. EL is calculated on an instrument level basis using assumptions which are reviewed on an annual basis. The EL for an individual loan is calculated by multiplying the principal
loan exposure by the PD and LGD percentages. The difference between the sum of the PCL for each line of business determined using the expected loss methodology and the consolidated provision is included in other reconciling items.
Webster allocates a majority of non-interest expenses to each business segment using a full-absorption costing process. Direct and indirect costs are analyzed and pooled by process and assigned to the appropriate business segment and corporate overhead costs are allocated to the business segments. Income tax expense is allocated to each business segment based on the effective income tax rate for the period shown.
The Chief Operating Decision Maker (CODM) uses full profitability measurement reports which are prepared for each operating segment, and include EL, and FTP. The differences between these report-based measures are reconciled to GAAP amounts in the Other category. These segment results are used as a basis for determining operating segment incentives, capital allocations, and product changes. The reports are reviewed on a monthly and quarterly basis and compare actual to planned results on a direct contribution basis, which is pretax. The operating segments that are generating revenue and revenue opportunities that exceed costs required to generate business and leverage fixed costs are allocated additional resources. The CODM typically has reduced resources to segments that are underperforming.
The Commercial Banking segment includes middle market, asset-based lending and commercial real estate.
Table 9: Commercial Banking Results for the years ended December 31,
Net income decreased $1.0 million, or 2.7%, in 2007 compared to 2006, primarily reflecting an increase in non-interest expense partially offset by an increase in net interest income. The $4.1 million increase in non-interest expense is attributable to increased charges for corporate technology, administration and other overhead costs. The $3.4 million increase in net interest income is primarily related to growth in asset-based and non-construction commercial real estate loans.
Net income increased $3.7 million, or 10.6%, in 2006 compared to 2005 reflecting increases in net interest income and non-interest income partially offset by increases in non-interest expense and the provision for credit losses. The $11.5 million increase in net interest income was due to growth in middle market loans, asset-based and non-construction commercial real estate loans. The increase in non-interest income is due to prepayment fees on commercial real estate loans. The increase in non-interest expenses reflects the continued investment in professionals to meet the volume growth in the business.
Included in the Retail Banking segment is retail, business and professional banking, and investment services.
Table 10: Retail Banking Results for the years ended December 31,
Net income decreased by $5.3 million, or 7.1%, compared to 2006 primarily reflecting growth in expenses that outpaced the growth in revenues. Net interest income increased $10.7 million, or 4.3%, primarily due to the annualized impact of the NewMil acquisition during the fourth quarter of 2006. The provision for credit losses increased $3.3 million or 51.6% due to acquisition of the NewMil loan portfolio and a change in classification of overdraft losses. The increase in non-interest income in 2007 of $20.4 million was driven by a change in the pricing of insufficient funds charges, increased debit card usage and a change in classification of overdraft losses. Non-interest expenses increased $36.0 million due to increased personnel and facilities costs associated with the NewMil acquisition, de novo branch expansion, increased charges for corporate technology and administration costs, a one-time write-off of software development costs and a change in accounting for deposit losses.
Net income increased $2.0 million, or 2.8%, in 2006 compared to 2005 reflecting increases in net interest income and non-interest income partially offset by increases in non-interest expenses. Net interest income increased $14.3 million, or 6.1%, and is attributable to an increase in interest income on loans and a decrease in total funds charge. The $11.2 million increase in non-interest income relates primarily to deposit service fees from insufficient funds charges, debit card fees and investment service fee income due to business growth. Non-interest expenses increased $23.4 million as a result of the acquisition of NewMil and de novo branch expansion.
Consumer Finance includes residential mortgage and consumer lending, as well as mortgage banking activities.
Table 11: Consumer Finance Results for the years ended December 31,
Net income decreased $17.3 million, or 28.8%, in 2007 compared to 2006 reflecting a decrease in net interest income and an increase in non-interest expenses, partially offset by an increase in non-interest income and a decrease in income tax expense and provision for credit losses. The $13.2 million decrease in net interest income is attributable to decreases in the residential mortgage portfolio due to the sale of $250 million of residential loans in December 2006 and the securitization of $1.0 billion of loans ($0.4 billion in December 2006 and $0.6 billion in January 2007). The $14.6 million increase in non-interest expense is attributable to increased charges for corporate technology and administrative costs, an increase in non-recurring expense related to the discontinuation of the Companys national wholesale mortgage banking activities, costs related to closing the operations of Peoples Mortgage Corporation and severance-related charges from line of business restructuring. The increase in non-interest income is related to gains from mortgage banking activities.
Net income decreased $8.8 million, or 12.7%, in 2006 compared to 2005 reflecting a decrease in net interest income and non-interest income, partially offset by decreases in income tax expense and provision for credit losses. The $12.1 million decrease in net interest income is attributable to a decrease in the residential mortgage portfolio due to a planned portfolio runoff throughout the year. The $2.9 million decrease in non-interest income is attributable to a loss on sale of residential mortgage loans and mortgage banking activities.
Other includes the Treasury unit, which is responsible for managing the investment portfolio and bank and customer funding needs. It also includes equipment financing, investment planning, insurance premium finance, government finance and HSA Bank.
Table 12: Other Results for the years ended December 31,
Net income increased $44.2 million in 2007 compared to 2006 reflecting increases in non-interest income and net interest income. Non-interest income increased $50.4 million primarily due to a $51.3 million loss on the write-down and subsequent sale of available for sale mortgage-backed securities that is reflected in non-interest income for the 2006 period. Net interest income increased $18.4 million, or 82.1%, compared to 2006. The increase reflects increases in the investment securities portfolio due to the securitization of loans described above, interest income on leases related to growth in the equipment financing portfolio and decreases in interest expense primarily due to a decline in the average total borrowings in 2007 when compared to the average balance sheet in 2006.
Net income decreased $44.1 million in 2006 compared to 2005 reflecting decreases in non-interest income and net interest income and an increase in non-interest expense. Non-interest income decreased $45.8 million primarily due to a $51.3 million loss on the write-down and subsequent sale of available for sale mortgage-backed securities during 2006, partially offset by an increase in deposit service fees generated by HSA Bank. Net interest income decreased $11.0 million due to increased interest expense on deposits and borrowings and lower interest income on securities partially offset by increased interest income on leases related to growth in the
equipment financing portfolio. The increase in non-interest expense is primarily due to increases in compensation and benefits related to HSA Bank and Wealth and Investment Advisors area.
Table 13: Reconciliation of business segments net income to consolidated net income.
Webster had total assets of $17.2 billion at December 31, 2007, an increase of $105.3 million, or 0.6%, from the previous year end. The increase in securities of $924.7 million was primarily due to the residential loan securitization that took place in the first quarter of 2007. The decrease in loans, net of allowance, of $487.9 million was also due to the loan securitization and to an increase of $40.4 million in the allowance for loan losses. Total liabilities increased $242.8 million with an increase in total borrowings of $350.8 million partially offset by a $104.2 million decrease in total deposits. The decrease in total deposits for the year is related to decreases in broker deposits. Websters loan to deposit ratio was 101.0% at December 31, 2007 compared to 103.7% at December 31, 2006.
At December 31, 2007, total shareholders equity of $1.7 billion represented a net decrease of $137.5 million from December 31, 2006. The change in equity for the year primarily consisted of net income of $96.8 million and $18.5 million related to stock options exercised, stock based compensation and the related tax benefits, which were more than offset by $64.6 million of dividends to common shareholders, $178.5 million to repurchase shares of common stock and a $19.6 million unfavorable change in unrealized losses on the available for sale securities portfolio, net of tax. At December 31, 2007, the tangible capital ratio was 5.89% compared to 6.72% at December 31, 2006.
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, 2007, the combined investment portfolios of Webster and Webster Bank totaled $2.7 billion. At December 31, 2007, Webster Banks portfolio consisted primarily of mortgage-backed and municipal 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 this 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 18 of Notes to Consolidated Financial Statements contained elsewhere within this 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 increased by $924.7 million from December 31, 2006. The available for sale securities portfolio increased by $273.9 million while the held to maturity portfolio increased by $653.3 million primarily due to the securitization of residential loans.
Table 14: 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 15: Loan portfolio composition at December 31,
Total loans decreased 3.5% during 2007. The residential mortgage portfolio declined by 17.7%, primarily the result of securitizing approximately $600 million in loans as part of the Companys balance sheet repositioning actions, partially offset by increases in commercial loans and commercial real estate loans of 3.8% and 8.2%, respectively, from the previous year end. Additionally, Consumer loans increased by 1.6%.
Table 16: Contractual maturities and interest-rate sensitivity of selected loan categories at December 31, 2007.
The contractual maturities are expected gross receipts from borrowers and do not reflect premiums, discounts and deferred costs.
Asset quality declined in 2007 as nonperforming assets increased to $121.1 million at December 31, 2007 from $61.8 million a year earlier. The increase in nonperforming assets was primarily the result of increases in non-performing loans in the liquidating indirect national construction and indirect out of market home equity portfolio. Residential and consumer non-performing loans within the continuing portfolio increased $12.1 million and $10.7 million, respectively, when compared to the balances at December 31, 2006. Non-performing loans within the liquidating portfolios increased $26.4 million when compared to balances at December 31, 2006. Total commercial nonperforming assets increased $9.6 mill