Webster Financial 10-Q 2007
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended June 30, 2007.
Commission File Number: 001-31486
WEBSTER FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
(Registrants telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. x Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.
Large accelerated filer x Accelerated filer ¨ Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
The number of shares of common stock outstanding as of July 31, 2007 was 54,454,841.
ITEM 1. INTERIM FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF CONDITION (unaudited)
See accompanying Notes to Consolidated Interim Financial Statements.
CONSOLIDATED STATEMENTS OF INCOME (unaudited)
See accompanying Notes to Consolidated Interim Financial Statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY (unaudited)
See accompanying Notes to Consolidated Interim Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
See accompanying Notes to Consolidated Interim Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited), continued
See accompanying Notes to Consolidated Interim Financial Statements.
Notes to the Consolidated Interim Financial Statements
NOTE 1: Basis of Presentation and Principles of Consolidation
The Consolidated Interim Financial Statements include the accounts of Webster Financial Corporation (Webster or the Company) and its subsidiaries. The Consolidated Interim Financial Statements and Notes thereto have been prepared in conformity with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. All significant inter-company transactions have been eliminated in consolidation. Amounts in prior period financial statements are reclassified whenever necessary to conform to current period presentations. The results of operations for the three or six months ended June 30, 2007 are not necessarily indicative of the results which may be expected for the year as a whole.
The preparation of the Consolidated Interim Financial Statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, as of the date of the Consolidated Interim Financial Statements, and the reported amounts of revenues and expenses for the periods presented. Actual results could differ from those estimates. Material estimates that are susceptible to near-term changes include the determination of the allowance for credit losses and the valuation allowance for the deferred tax asset. These Consolidated Interim Financial Statements should be read in conjunction with the audited Consolidated Financial Statements and Notes thereto included in Websters Annual Report on Form 10-K for the year ended December 31, 2006.
NOTE 2: Sale Transactions
On March 30, 2007, Webster announced the sale of certain branches of its Peoples Mortgage Corporation (PMC) subsidiary. The branch offices in Severna Park and Rockville, Maryland, and Hamden Connecticut were sold to 1st Mariner Mortgage, a division of 1st Mariner Bank of Baltimore, Maryland. In connection with this sale, Webster recorded a pre-tax charge of $2.3 million in its first quarter 2007 results. The expenses relate primarily to severance, lease termination and other transaction costs. On April 30, 2007, Webster sold a PMC branch office located in Andover, Massachusetts to 1st Mariner Mortgage. PMC is a subsidiary of Webster Bank, National Association (Webster Bank).
NOTE 3: Securities
A summary of trading, available for sale and held to maturity securities follows:
As of June 30, 2007, the fair value of equity securities consisted of FHLB stock of $69.3 million, FRB stock of $41.7 million, common stock of $45.0 million and preferred stock of $20.7 million. The fair value of equity securities at December 31, 2006 consisted of FHLB stock of $96.0 million, FRB stock of $41.7 million, common stock of $40.2 million and preferred stock of $20.0 million. During the six months ended June 30, 2007, Webster purchased $50.6 million of agency mortgage backed securities as part of its ongoing Community Reinvestment Act program that are classified as available for sale.
The following table identifies temporarily impaired investment securities as of June 30, 2007 segregated by length of time the securities have been in a continuous unrealized loss position.
The following table identifies temporarily impaired investment securities as of December 31, 2006 segregated by length of time the securities had been in a continuous unrealized loss position.
Unrealized losses on fixed income securities result from the cost basis of securities being greater than current market value. This will generally occur as a result of an increase in interest rates since the time of purchase, a structural change in an investment or from deterioration in credit quality of the issuer. Management has and will continue to evaluate impairments, whether caused by adverse interest rate or credit movements, to determine if they are other-than-temporary.
In accordance with applicable accounting literature, Webster must demonstrate an ability and intent to hold temporarily impaired securities until full recovery of their cost basis. Management uses both internal and external information sources to arrive at the most informed decision. This quantitative and qualitative assessment begins with a review of general market conditions and changes to market conditions, credit, investment performance and structure since the prior review period. The ability to hold temporarily impaired securities will involve a number of factors, including: forecasted recovery period based on average life; whether its return provides satisfactory carry relative to funding sources; Websters capital, earnings and cash flow positions; and compliance with various debt covenants, among other things. As of June 30, 2007, Webster had the ability and intent to hold all temporarily impaired securities to full recovery, which may be until maturity.
Estimating the recovery period for equity securities will include analyst forecasts, earnings assumptions and other company specific financial performance metrics. In addition, this assessment will incorporate general market data, industry and sector cycles and related trends to determine a reasonable recovery period.
In November 2006, Webster announced its intention to securitize $1.0 billion of residential mortgage loans and hold the resulting securities in its held-to-maturity securities portfolio, primarily for collateral purposes. As of December 31, 2006, $371.1 million of these loans had been securitized; an additional $633.0 million in loans were securitized in January 2007. A separate mortgage servicing asset was not recognized in these transactions. The held-to-maturity securities were recorded at an amortized cost equal to the carrying amount of the securitized loans.
Managements evaluation of securities impairment losses at June 30, 2007 began with recognition that market yields still reflect the impact of 17 separate interest rate increases totaling 425 basis points by the Federal Reserve from June 2004 through June 2006. Through June 30, 2007, the Federal Reserves Open Market Committee has held the federal funds rate target at 5.25%.
Three available for sale corporate securities totaling $10.8 million at June 30, 2007, with an unrealized loss of $0.2 million, were impaired for twelve consecutive months or longer due to higher interest rates subsequent to their purchase. The Company invests in corporate securities that are unrated, below investment grade and investment grade. Securities that are unrated or below investment grade have undergone an internal credit review. As a result of the credit review of the issuers, management has determined that there has been no deterioration in credit quality subsequent to the purchase or last review period. These securities are performing as projected. Management does not consider these investments to be other-than temporarily impaired based on its credit reviews and Websters ability and intent to hold these investments to full recovery of the cost basis.
Fifty-one held to maturity municipal securities totaling $20.1 million at June 30, 2007, with an unrealized loss of $0.3 million, were impaired for twelve consecutive months or longer due to higher interest rates subsequent to their purchase. Most of these bonds are insured AAA rated general obligation bonds with stable ratings. There were no significant credit downgrades since the last review period. These securities are currently performing as anticipated. Management does not consider these investments to be other-than-temporarily impaired. Webster has the ability and intent to hold these investments to full recovery of the cost basis.
At June 30, 2007, Webster had $580.4 million in held to maturity securities (including the municipal securities described above) with an unrealized loss of $30.2 million for twelve months or longer. These securities have had varying levels of unrealized loss due to higher interest rates subsequent to their purchase. Approximately 99 percent of that unrealized loss, or $29.9 million, was concentrated in 22 mortgage-backed securities held to maturity totaling $560.3 million in fair value. These securities carry AAA ratings or Agency-implied AAA credit ratings and are currently performing as expected. Management does not consider these investments to be other-than-temporarily impaired and Webster has the ability and intent to hold these investments to full recovery of the cost basis. Management expects that recovery of these temporarily impaired securities will occur over the weighted-average estimated remaining life of these securities.
There were no impairment write-downs of securities during the six months ended June 30, 2007 and 2006, respectively.
NOTE 4: Loans Held for Sale
Loans held for sale had a total carrying value of $372.9 million and $354.8 million at June 30, 2007 and December 31, 2006, respectively. The composition of loans held for sale at June 30, 2007 and December 31, 2006 follows:
At June 30, 2007 and December 31, 2006, residential mortgage origination commitments totaled $293.6 million and $305.1 million, respectively. Residential commitments outstanding at June 30, 2007 consisted of adjustable rate and fixed rate mortgages of $11.1 million and $282.5 million, respectively, at rates ranging from 5.375% to 10.15%. Residential commitments outstanding at December 31, 2006 consisted of adjustable rate and fixed rate mortgages of $17.5 million and $287.6 million, respectively, at rates ranging from 5.50% to 8.25%. Commitments to originate loans generally expire within 60 days. At June 30, 2007 and December 31, 2006, Webster also had outstanding commitments to sell residential mortgage loans of $573.1 million and $652.4 million, respectively. See Note 15 for a further discussion of loan origination and sale commitments.
During the three months ended June 30, 2007, a lower of cost or market adjustment of $1.2 million was recorded on the construction loans held-for-sale portfolio. This adjustment was charged to noninterest income (mortgage banking activities). Subsequent to the write-down, $96.3 million of construction loans that were not under contract were transferred from the held-for-sale portfolio to the residential mortgage portfolio. Construction loans totaling $1.8 million remained in the held-for-sale portfolio at June 30, 2007 and will be sold and delivered in the third quarter. During the first quarter of 2007, the Company recorded a $700,000 write-down in value on one loan in Florida that had been classified as held-for-sale.
NOTE 5: Loans, Net
A summary of loans, net follows:
At June 30, 2007, total loans included $18.5 million of net premiums and $48.1 million of net deferred costs, compared with $24.3 million of net premiums and $44.6 million of net deferred costs at December 31, 2006. The unadvanced portions of closed loans totaled $570.3 million and $512.9 million at June 30, 2007 and December 31, 2006, respectively.
At June 30, 2007, Webster had $342.6 million in construction loans within its portfolio of which $151.8 million were originated by its National Wholesale Construction Lending (NCL) operation using mortgage brokers approved by Webster. At June 30, 2007 and December 31, 2006, the amount of unused credit on construction loans was $124.3 million and $131.8 million, respectively.
At June 30, 2007 and December 31, 2006, unused portions of home equity credit lines extended were $2.2 billion and $2.0 billion, respectively. Unused commercial lines of credit, letters of credit, standby letters of credit, equipment financing commitments and outstanding commercial loan commitments totaled $2.6 billion at June 30, 2007 and $3.2 billion at December 31, 2006. Other consumer loan commitments totaled $50.5 million and $65.3 million at June 30, 2007 and December 31, 2006, respectively.
Webster is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and commitments to sell residential first mortgage loans and commercial loans. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the Consolidated Statements of Condition.
Future loan commitments represent residential and commercial mortgage loan commitments, commercial loan and equipment financing commitments, letters of credit and commercial and home equity unused credit lines. The interest rates for these loans are generally established shortly before closing. The interest rates on home equity lines of credit adjust with changes in the prime rate.
A majority of the outstanding letters of credit are performance stand-by letters of credit within the scope of Financial Accounting Standards Board (FASB) Interpretation No. (FIN) 45. These are irrevocable undertakings by Webster, as guarantor, to make payments in the event a specified third party fails to perform under a nonfinancial contractual obligation. Most of the performance stand-by letters of credit arise in connection with lending relationships and have a term of one year or less.
The risk involved in issuing stand-by letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance sheet products. At June 30, 2007, Websters stand-by letters of credit totaled $168.6 million. At June 30, 2007, the fair value of stand-by letters of credit is considered insignificant to the unaudited interim financial statements.
NOTE 6: Allowance for Credit Losses
The allowance for credit losses is maintained at a level adequate to absorb probable losses inherent in the loan portfolio and in unfunded credit commitments. This allowance is increased by provisions charged to operating expense and by recoveries on loans previously charged-off and reduced by charge-offs on loans.
A summary of the changes in the allowance for credit losses follows:
NOTE 7: Goodwill and Other Intangible Assets
The following tables set forth the carrying values of goodwill and other intangible assets, net of accumulated amortization:
Changes in the carrying amount of goodwill for the six months ended June 30, 2007 are as follows:
The addition to goodwill is principally due to a final year earn-out of contingent consideration related to a prior business combination, partially offset by an adjustment due to the resolution of various acquisition related tax liabilities.
Amortization of intangible assets for the six months ended June 30, 2007, totaled $6.8 million. Estimated annual amortization expense of current intangible assets with finite useful lives, absent any impairment or change in estimated useful lives, is summarized below.
NOTE 8: Income Taxes
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at June 30, 2007 and December 31, 2006 are summarized below. Temporary differences result from the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Due to uncertainties of realization, a valuation allowance has been established for the full amount of the net state deferred tax asset applicable to Connecticut, and for substantially all Massachusetts and Rhode Island net state deferred tax assets.
Management believes it is more likely than not that Webster will realize its net deferred tax assets, based upon its recent historical and anticipated future levels of pre-tax income. There can be no absolute assurance, however, that any specific level of future income will be generated.
On January 1, 2007, Webster adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes An Interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprises financial statements in accordance with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 also prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In addition, FIN 48 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The provisions of FIN 48 are to be applied to all tax positions upon initial adoption of this standard. Tax positions must meet the more-likely-than-not recognition threshold at the effective date in order for the related tax benefits to be recognized or continue to be recognized upon adoption of FIN 48. As a result of the adoption of FIN 48, Webster recognized a $1.4 million decrease in the liability for unrecognized tax benefits, which was accounted for as an addition to the January 1, 2007, balance of retained earnings. After the impact of recognizing the decrease in the liability noted above, Websters net unrecognized tax benefits totaled $5.9 million. Of that amount, $3.9 million, if recognized, would affect the effective tax rate, and the remainder would reduce goodwill. Webster recognizes accrued interest and penalties related to unrecognized tax benefits, where applicable, in income tax expense. As of the adoption date, Webster had net accrued interest expense related to unrecognized tax benefits of $639,000. At June 30, 2007, Webster had net accrued interest expense related to unrecognized tax benefits of $701,000.
Currently, the Company is under examination from various taxing authorities. It is reasonably possible that at least some of these examinations will conclude in the next 12 months and result in a change in our unrecognized tax benefits. However, quantification of an estimated range of the change in the Companys unrecognized tax benefits cannot be made at this time.
Webster and its subsidiaries file Federal and various state and local income tax returns. With few exceptions, Webster is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2002.
NOTE 9: Deposits
The following table summarizes the period end balance and the composition of deposits:
Interest expense on deposits is summarized as follows:
NOTE 10: Federal Home Loan Bank Advances
Advances payable to the Federal Home Loan Bank (FHLB) are summarized as follows:
Webster Bank had additional borrowing capacity of approximately $1.5 billion from the FHLB at June 30, 2007 and $1.6 billion at December 31, 2006. Advances are secured by a blanket security agreement against certain qualifying assets, principally residential mortgage loans. At June 30, 2007 and December 31, 2006, Webster Bank had unencumbered investment securities available to secure additional borrowings. If these securities had been used to secure FHLB advances, borrowing capacity at June 30, 2007 and December 31, 2006 would have been increased by an additional $356.5 million and $849.0 million, respectively. At June 30, 2007 Webster Bank was in compliance with the FHLB collateral requirements.
NOTE 11: Securities Sold Under Agreements to Repurchase and Other Short-term Debt
The following table summarizes securities sold under agreements to repurchase and other short term borrowings:
The following table sets forth certain information on short-term repurchase agreements:
NOTE 12: Shareholders Equity
A total of 1,973,753 shares of common stock were repurchased during the first six months of 2007 at an average cost of $44.09 per common share. Of the shares repurchased, 1,000,902 shares were repurchased as part of the July 2003, 2.3 million share stock buyback program, which at June 30, 2007 was complete. On June 5, 2007 the Company announced that its Board of Directors authorized the repurchase of up to 5 percent of the Companys common stock or approximately 2.8 million of its 55.8 million shares outstanding at that time. Of the shares repurchased during the first six months of 2007, 968,300 shares were repurchased as part of this new program. Management intends to continue to repurchase shares of common stock for the foreseeable future given the attainment of higher tangible capital levels during 2006. The tangible capital ratio at June 30, 2007 was 6.32% compared to 6.46% at December 31, 2006 and 5.48% at June 30, 2006. A total of 1,145,247 shares of common stock were repurchased during the first six months of 2006 at an average cost of $46.75 per common share. Of the shares repurchased, 1,126,881 shares were repurchased as part of the July 2003 stock buyback program.
Webster does occasionally repurchase its common securities on the open market to fund equity compensation plans for its employees. Additionally, Webster repurchases its shares from employees who surrender a portion of their shares received through the Companys stock based compensation plans to cover their associated minimum income tax liabilities. During the six months ended June 30, 2007 and 2006, Webster repurchased 4,551 and 18,366 shares, respectively, outside of the publicly announced repurchase programs.
Accumulated other comprehensive loss is comprised of the following components:
NOTE 13: Regulatory Matters
Capital guidelines issued by the Federal Reserve Board and the Office of the Comptroller of Currency of the United States (OCC) require Webster and its banking subsidiary to maintain certain minimum ratios, as set forth below. At June 30, 2007, Webster and Webster Bank, were deemed to be well capitalized under the regulations of the Federal Reserve Board and the OCC, respectively, and in compliance with the applicable capital requirements.
The following table provides information on the capital ratios:
NOTE 14: Business Segments
Retail Banking and Commercial Banking have been identified as reportable operating segments. The balance of Websters activity is reflected in Other. The methodologies and organizational hierarchies that define the business segments are periodically reviewed and revised. The following table presents the operating results and total assets for Websters reportable segments.
Three months ended June 30, 2007
Six months ended June 30, 2007
Retail Banking includes deposit activities, distribution network costs, business and professional banking, consumer finance, wealth management and insurance. For the six months ended June 30, 2007, the increase in noninterest income is primarily due to deposit services fees reflecting an increased contribution from HSA Bank, a division of Webster Bank, and growth in NSF and Debit Card fees, as well as investment service fee income due to business growth. The increase in noninterest expense is primarily attributable to increases in retail distribution costs associated with the acquisition of NewMil, HSA Bank expenses, write-off of software development costs due to the cancellation of a technology project, new revenue generating personnel, the ongoing build out of the compliance function, costs related to closing the remaining operations of Peoples Mortgage Corporation and severance-related charges from ongoing line of business restructuring.
Commercial Banking includes middle market, commercial real estate, asset-based lending, equipment financing, insurance premium financing and cash management. Net income decreased $1.8 million for the six months ended June 30, 2007 when compared to the comparable period in 2006. The decreases are attributable to increases in noninterest expense, primarily due to higher compensation and benefits costs attributable to new revenue generating personnel, and increases in overhead costs. Offsetting the decreases in net income are increases in net interest income due to loan growth.
Other includes indirect expenses allocated to segments. These expenses include administration, finance, technology, processing operations and other support functions. Other also includes the Treasury unit, which is responsible for managing the wholesale investment portfolio and funding needs and expenses not allocated to the business lines, the residual impact of methodology allocations such as the provision for credit losses and funds transfer pricing.
Management uses certain methodologies to allocate income and expenses to the business lines. Funds transfer pricing assigns interest income and interest expense to each line of business on a matched maturity funding concept based on each business assets and liabilities. The provision for credit losses is allocated to business lines on an expected loss basis. Expected loss is an estimate of the average loss rate that individual credits will experience over an economic cycle, based on historical loss experiences and the grading assigned each loan. This economic cycle methodology differs from that used to determine our consolidated provision for credit losses, which is based on an evaluation of the adequacy of the allowance for credit losses considering the risk characteristics in the portfolio at a point in time. The difference between the sum of the provisions for each line of business determined using the expected loss methodology and the consolidated provision is included in Other. Taxes are allocated to each segment generally based on the effective rate for the period shown.
NOTE 15: Derivative Financial Instruments
At June 30, 2007, there were outstanding interest rate swaps with a total notional amount of $552.5 million which are used to hedge FHLB advances, repurchase agreements and long-term debt (subordinated notes and senior notes). The swaps are used to transform the debt from fixed rate to floating rate and qualify for fair value hedge accounting under SFAS No. 133. Of the total, $202.5 million of the interest rate swaps mature in 2008, $200.0 million in 2013 and $150.0 million in 2014, with an equal amount of the hedged debt also maturing on these dates. At December 31, 2006, there were outstanding interest rate swaps with a notional amount of $752.5 million.
Webster transacts certain derivative products with its customer base, primarily interest rate swaps and, to a lesser extent, interest rate caps. These customer derivatives are offset with matching derivatives with other counterparties in order to minimize risk. Exposure with respect to these derivatives is largely limited to nonperformance by either the customer or the other counterparty. The notional amount of customer derivatives and the related counterparty derivatives each totaled $284.1 million at June 30, 2007 and $274.5 million at December 31, 2006. The customer derivatives and the related counterparty derivatives are marked to market and any difference is reflected in noninterest income.
The fair values and notional amounts of derivatives at June 30, 2007 and December 31, 2006 are summarized below:
Certain derivative instruments, primarily forward sales of mortgage backed securities (MBS), are utilized by Webster Bank in its efforts to manage risk of loss associated with its mortgage loan commitments and mortgage loans held for sale. Prior to closing and funding a single-family residential mortgage loan, an interest-rate locked commitment is generally extended to the borrower. During the period from commitment date to closing date, Webster Bank is subject to the risk that market rates of interest may change. If market rates rise, investors generally will pay less to purchase such loans resulting in a reduction in the gain on sale of the loans or, possibly, a loss. In an effort to mitigate such risk, forward delivery sales commitments, under which Webster agrees to deliver whole mortgage loans to various investors or issue MBS, are established. At June 30, 2007, outstanding rate locks totaled approximately $293.6 million and the outstanding commitments to sell residential mortgage loans totaled $573.1 million. Forward sales, which include mandatory forward commitments of approximately $532.5 million and best efforts forward commitments of approximately $40.6 million at June 30, 2007, establish the price to be received upon the sale of the related mortgage loan, thereby mitigating certain interest rate risk. Webster Bank will still have certain execution risk, that is, risk related to its ability to close and deliver to its investors the mortgage loans it has committed to sell.
The interest rate locked loan commitments and forward sales commitments are recorded at fair value, with changes in fair value recorded in current period earnings. Loans held for sale are carried at the lower of aggregate cost or fair value.
NOTE 16: Pension and Other Benefits
The following table provides information regarding net benefit costs for the periods shown:
In December 2006, Webster announced that both the Webster Pension Plan and the supplemental pension plan will be frozen as of December 31, 2007. Employees will no longer accrue additional qualified or supplemental retirement income after December 31, 2007. Furthermore, employees hired after December 31, 2006 will not be eligible to enter either plan. At the same time, Webster announced enhancements to its 401(k) qualified and supplemental retirement savings plans. The enhancements will take effect April 1, 2007 for employees hired after December 31, 2006 and January 1, 2008 for all other employees.
An updated estimate of 2007 pension expense was performed by the Plans actuaries and resulted in a decrease in net periodic benefit costs of $1.0 million for the first six months and $2.0 million for the full year 2007. Contributions will be made as deemed appropriate by management in conjunction with the Plans actuaries. The Company currently estimates there will be no contributions to the Webster Bank Pension Plan in 2007.
Webster assumed the obligations of the FIRSTFED pension plan. The plan was not merged into the Webster Bank Pension Plan, but instead will continue to be included in the multiple-employer plan administered by Pentegra (the Fund). The Fund does not segregate the assets or liabilities of its participating employers in the on-going administration of this plan and accordingly, disclosure of FIRSTFED accumulated vested and nonvested benefits is not possible. Webster has made $1.0 million in contributions in the first six months and estimates it will make approximately $2.6 million in total contributions during calendar year 2007.
On July 23, 2007, the Companys Board Of Directors approved the merger of NewMils Pension Plan into Websters Pension Plan and the merger of the NewMil Bank Savings and Protection Plan (the NewMil 401(k)Plan) into Websters 401(k) Plan, effective as of August 1, 2007.
NOTE 17: Other Comprehensive Income
The following table summarizes the components of other comprehensive income:
NOTE 18: Accounting Adjustment
During the second quarter of 2007, management identified an error related to an unintentional over-accrual of insurance revenues between 2002 and 2005, caused by the accrual of direct bill revenues at a rate greater than ultimate collections. The effect was not material in any one period and resulted in a cumulative over-accrual of approximately $4.2 million or $2.7 million after-tax. Management evaluated the financial statement impact of this error and recorded a cumulative decrease to opening retained earnings of $2.7 million, as well as a $4.2 million reduction in other assets for the over-accrual and a $1.5 million decrease in other liabilities for the related tax effect. The adjustment had no effect on the consolidated statements of income for any of the periods presented herein.
NOTE 19: Recent Accounting Pronouncements
On June 14, 2007, the EITF reached a final consensus on Issue No. 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment Awards. This consensus was ratified by the FASB on June 27, 2007. This Issue states that tax benefits received on dividends paid to employees associated with their unvested stock compensation awards should be recorded in additional-paid-in-capital (APIC) for awards expected to vest. Currently, such dividends are a permanent tax deduction reducing the annual effective income tax rate. This Issue also requires that such tax benefits be reclassified between APIC and income tax expense in subsequent periods for any changes in forfeiture estimates. Tax benefits for dividends recorded to APIC would be available to absorb future stock compensation tax deficiencies. This Issue is to be applied prospectively to dividends declared in fiscal years beginning after December 15, 2007. Retrospective application of this Issue is prohibited. This Issue will not have a material effect on Websters financial statements.
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, Fair Value Measurements (SFAS 157), which is effective for fiscal years beginning after November 15, 2007 and for interim periods within those years. This statement defines fair value, establishes a framework for measuring fair value and expands the related disclosure requirements. The Company is currently evaluating the potential impact of adopting SFAS 157.
In February 2007, the FASB issued SFAS No. 159 The Fair Value Option for Financial Assets and Financial Liabilities Including an amendment of FASB No. 115 to permit measurement of recognized financial assets and liabilities at fair value (the fair value option). Unrealized gains and losses on items for which the fair value option has been taken are reported in earnings at each subsequent reporting date. Upfront costs and fees related to items reported under the fair value option are recognized in earnings as incurred and not deferred. SFAS 159 is effective for fiscal years beginning after November 15, 2007. Because SFAS 159 permits management to determine which, if any, financial assets and liabilities to measure at fair value, Websters management is currently evaluating what, if any, impact the adoption of SFAS 159 will have on Websters consolidated financial position, results of operations or cash flows.
Forward Looking Statements
This report contains forward looking statements within the meaning of the Securities Exchange Act of 1934, as amended. Actual results could differ materially from management expectations, projections and estimates. Factors that could cause future results to vary from current management expectations include, but are not limited to, general economic conditions, legislative and regulatory changes, monetary and fiscal policies of the federal government, changes in tax policies, rates and regulations of federal, state and local tax authorities, changes in interest rates, deposit flows, the cost of funds, demand for loan products, demand for financial services, competition, changes in the quality or composition of Websters loan and investment portfolios, changes in accounting principles, policies or guidelines, and other economic, competitive, governmental and technological factors affecting Websters operations, markets, products, services and prices. Some of these and other factors are discussed in Websters annual and quarterly reports previously filed with the Securities and Exchange Commission. Such developments, or any combination thereof, could have an adverse impact on Websters financial position and results of operations. Except as required by law, Webster does not undertake to update any such forward looking statements.
Description of Business
Webster Financial Corporation (Webster or the Company), a bank holding company and financial holding company under the Bank Holding Company Act of 1956, as amended, was incorporated under the laws of Delaware in 1986. Webster, on a consolidated basis, at June 30, 2007 had assets of $16.9 billion and shareholders equity of $1.8 billion. Websters principal assets are all of the outstanding capital stock of Webster Bank, National Association (Webster Bank), and Webster Insurance, Inc. (Webster Insurance). Webster, through its various non-banking financial services subsidiaries, delivers financial services to individuals, families and businesses throughout southern New England and eastern New York State, and equipment financing, asset-based lending, mortgage origination and insurance premium financing throughout the United States. Webster Bank provides commercial banking, retail banking, health savings accounts (HSAs), consumer financing, mortgage banking, trust and investment services through 177 banking offices, 337 ATMs, and its Internet website (www.websteronline.com). Webster is a bank holding company and is registered with the Board of Governors of the Federal Reserve System (Federal Reserve) under the Bank Holding Company Act. As such the Federal Reserve is Websters primary regulator, and Webster is subject to extensive regulation, supervision and examination by the Federal Reserve. Webster Bank is regulated by the Office of the Comptroller of the Currency. Websters common stock is traded on the New York Stock Exchange under the symbol of WBS. Websters financial reports can be accessed through its website within 24 hours of filing with the SEC.
Critical Accounting Policies
The Companys significant accounting policies are described in Note 1 to the consolidated financial statements included in the 2006 Annual Report on Form 10-K. The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and to disclose contingent assets and liabilities. Actual results could differ from those estimates. Management has identified accounting for the allowance for credit losses, valuation of goodwill/other intangible assets and analysis for impairment, deferred income taxes and pension and other post retirement benefits as the Companys most critical accounting policies and estimates in that they are important to the portrayal of our financial condition and results, and they require managements most subjective and complex judgment as a result of the need to make estimates about the effect of matters that are inherently uncertain. These accounting policies, including the nature of the estimates and types of assumptions used, are described throughout this Managements Discussion and Analysis and the December 31, 2006 Managements Discussion and Analysis included in the Annual Report on Form 10-K.
RESULTS OF OPERATIONS
Websters net income was $35.5 million for the three months ended June 30, 2007, compared to $43.1 million for the three months ended June 30, 2006, a decrease of 17.6%. Net income per diluted share was $0.63 for the three months ended June 30, 2007 compared to $0.81 for the comparable period in 2006. For the six months ended June 30, 2007, Websters net income was $70.5 million compared to $87.0 million for the comparable period in 2006, a decrease of 19.0%. Net income per diluted share was $1.25 for the six months ended June 30, 2007 compared to $1.63 for the comparable period in 2006. The year-over-year decrease is attributable to $8.9 million ($5.8 million net of taxes) in redemption premiums and unamortized issuance costs related to the redemption of Webster Capital Trust I and II securities, closing costs of $2.3 million ($1.5 million, net of taxes) related to the remaining operations of PMC, severance related charges from ongoing restructuring in insurance and other lines of business of $4.1 million ($2.7 million, net of taxes), the write-off of software development costs of $3.4 million ($2.2 million, net of taxes) and $1.6 million ($1.1 million, net of taxes) related to the write down in value of various residential construction loans classified as held for sale, partially offset by a $2.1 million ($1.4 million net of taxes) gain on positions in Webster Capital Trust I and II securities positions that were held by Webster. The year-over-year comparisons are also impacted by the interest rate environment, and the effect that rising short-term interest rates and a flattening of the yield curve had on our net interest margin. The effect of these market conditions has been partially offset by the growth in the loan portfolio, particularly in higher yielding commercial and consumer loans.
In addition to the actions regarding PMC and residential construction lending discussed above, during the first quarter of 2007, Webster terminated the mezzanine lending operations of Webster Banks subsidiary, Webster Growth Capital.
During the second quarter management completed its strategic review of the Company, which began in the fourth quarter of 2006, and the organizational review, which was announced on February 28, 2007. The previously announced strategic review looked at the bank and all lines of business to focus on core competencies, identify operational efficiencies and position Webster to realize its vision of becoming New Englands bank. This process encompassed evaluating the contribution, growth potential, fit and alignment of each segment and line of business with the Companys goals and mission. The strategic review resulted in, as the Company had previously announced at the end of the first quarter of 2007, the decision to close Peoples Mortgage Company; terminate mezzanine lending operations (Webster Growth Capital); discontinue construction lending outside of its primary New England market area (National Construction Lending); restructure its insurance operations; and outsource the back office operations of Webster Investment Services.
Additionally, the Company has determined additional strategic review outcomes, including a decision to focus on in-market and contiguous franchise growth, and that future lending relationships outside the Northeast will be direct. Regarding mortgage banking, the focus will be on the New England and Mid-Atlantic states with reduced national presence. Regarding insurance, the Company announced it is exploring strategic alternatives that may result in the sale of Webster Insurance. As part of that process, the Company is seeking to include a relationship to continue selling insurance products. With respect to HSA Bank, the Company announced it is evaluating strategic alliances as well as additional investment in HSA Bank to continue capturing a high market share in the fast-growing health savings account deposit segment.
The Company also announced specific actions it intends to open four new branch locations in second half of 2007 (New Rochelle, NY: Longmeadow and East Longmeadow, MA; Woodbridge, CT), and six to eight new locations in 2008. The Company will optimize the existing franchise by combining certain offices into stronger locations and using efficiency gained to fund investment in de novo.
The Company also detailed a facilities strategy to consolidate back office operations into one location and a regional hub approach to consolidate facilities in certain cities.
The stated goal of the organizational review was to implement a structure that would result in a more efficient and effective organization. The organization review resulted in the creation of: an Office of the Chief Executive Officer: an Executive Management Committee; a new position the Chief Administrative Officer, who is responsible for all shared services functions; restructuring and streamlining of governance committees and layers of management; and a restructured approach to risk management that distinctly addresses credit, operating and interest rate risk.
Selected financial highlights are presented in the following table.
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 $130.4 million for the three months ended June 30, 2007, compared to $126.8 million for the comparable period in 2006, an increase of $3.6 million or 2.8%. For the six months ended June 30, 2006 net interest income totaled $258.4 million compared to $257.0 million for the comparable period in 2006, an increase of $1.4 million or 0.5%. In the second quarter of 2006, the timing of FHLB dividends was changed and resulted in Webster not recording any dividend income on its investment. The approximate dividend would have been $1.8 million for the three months ended June 30, 2006. The dividend for the three months ended June 30, 2007 was $1.3 million.
The increase in net interest income is largely due to Websters balance sheet repositioning actions as proceeds from the sale of securities were used to pay down high cost borrowings. For the three months ending June 30, 2007, the yield on interest earning assets increased 51 basis points while the cost of interest bearing liabilities rose 20 basis points. For the six months ending June 30, 2007, the yield on interest earning assets rose 57 basis points while the cost of interest bearing liabilities rose 36 basis points. As a result, the net interest margin for the three months ended June 30, 2007 was 3.47%, an increase of 34 basis points from the comparable period in 2006. For the six months ended June 30, 2007, the net interest margin was 3.44%, an increase of 26 basis points from the comparable period in 2006.
Net interest income can change significantly from period to period based on general levels of interest rates, customer prepayment patterns, the mix of interest earning assets and the mix of interest bearing and non-interest bearing deposits and borrowings. Webster manages the risk of changes in interest rates on its net interest income through an Asset/Liability Management Committee and through related interest rate risk monitoring and management policies. See Asset/Liability Management and Market Risk for further discussion of 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. The table presented below is based upon the fully tax-equivalent basis.
Interest income, on a fully tax-equivalent basis, for the three months ended June 30, 2007 increased $1.1 million, or 0.4%, from the comparable period in 2006, and for the six months ended June 30, 2007, rose $9.4 million, or 1.9%, from the comparable period in 2006. The increase in short-term interest rates had a favorable impact on interest sensitive loans as well as higher rates on new volumes. The second quarter average balance for loans was $12.3 billion, a decrease of 2.4% from $12.6 billion for the comparable period in 2006. The year to date average balance for loans was $12.4 billion, a decrease of 1.1% from $12.5 billion for the comparable period in 2006.
The yield on interest-earning assets for the six months ended June 30, 2007 increased 57 basis points from the comparable period in 2006. The increase reflects the rising interest rate environment in these periods and the reduction in low yielding assets.
The loan portfolio yield for the six months ended June 30, 2007 increased 34 basis points to 6.78% and comprised 81.2% of average interest-earning assets compared to a loan portfolio yield of 6.44% and comprising 76.6% of average interest- earning assets for the six months ended June 30, 2006.
Interest expense for the three months ended June 30, 2007 decreased $2.8 million, or 2.3%, from the comparable period in 2006 primarily due to lower FHLB borrowings and the call of the Webster Capital Trust I and II securities. For the six months ended June 30, 2007, interest expense increased $7.5 million, or 3.2%, from the comparable period in 2006. The increase for the six months was primarily due to the rising short-term interest rates and continued consumer preference for higher yielding certificates of deposit. Offsetting the increase was a decrease in borrowings as cash flows from the investment portfolio were used to reduce these high-cost funding sources.
The cost of interest bearing liabilities was 3.25% for the three months ended June 30, 2007, an increase of 20 basis points compared to 3.05% for the comparable period in 2006. For the six months ended June 30, 2007, the cost of interest bearing liabilities was 3.27%, an increase of 36 basis points from 2.91% for the comparable period in 2006. Deposit costs for the six months ended June 30, 2007 increased to 2.88% from 2.30%, an increase of 58 basis points from the comparable period in 2006. Total borrowing yields for the six months ended June 30, 2007 increased 70 basis points to 5.34% from 4.64% for the comparable period in 2006.
The following summarizes the major categories of assets and liabilities together with their respective interest income or expense and the rates earned or paid by Webster.