Webster Financial 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended June 30, 2008.
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. þ Yes ¨ No
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. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No þ
The number of shares of common stock outstanding as of July 31, 2008 was 52,547,675.
ITEM 1. INTERIM FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS (unaudited)
See accompanying Notes to Consolidated Interim Financial Statements.
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
See accompanying Notes to Consolidated Interim Financial Statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME (unaudited)
See accompanying Notes to Consolidated Interim Financial Statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
WEBSTER FINANCIAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited), continued
See accompanying Notes to Consolidated Interim Financial Statements.
Notes to the Consolidated Interim Financial Statements
NOTE 1: Summary of Significant Accounting Policies and Other Matters
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, 2008 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 goodwill impairment, other-than-temporary impairment on securities, 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, 2007.
Recent Accounting Pronouncements
In December 2007, the Financial Accounting Standards Board (FASB) issued revised Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations, (SFAS No. 141(R)). SFAS No. 141(R) retains the fundamental requirements of SFAS No. 141 that the acquisition method of accounting (formerly the purchase method) be used for all business combinations; that an acquirer be identified for each business combination; and that intangible assets be identified and recognized separately from goodwill. SFAS No. 141(R) requires the acquiring entity in a business combination to recognize the assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree at the acquisition date, measured at their fair values as of that date, with limited exceptions. Additionally, SFAS No. 141(R) changes the requirements for recognizing assets acquired and liabilities assumed arising from contingencies and recognizing and measuring contingent consideration. SFAS No. 141(R) also enhances the disclosure requirements for business combinations. SFAS No. 141(R) applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008 and may not be applied before that date.
In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statementan amendment of ARB No. 51 (SFAS No. 160). SFAS No. 160 amends Accounting Research Bulletin No. 51, Consolidated Financial Statements to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Among other things, SFAS No. 160 clarifies that a noncontrolling interest in a subsidiary is an ownership interest in the consolidated entity that should be reported as equity in the consolidated financial statements and requires consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the noncontrolling interest. SFAS No. 160 also amends SFAS No. 128, Earnings per Share, so that earnings per share calculations in consolidated financial statements will continue to be based on amounts attributable to the parent. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008 and is applied prospectively as of the beginning of the fiscal year in which it is initially applied, except for the presentation and disclosure requirements which are to be applied retrospectively for all periods presented. SFAS No. 160 is not expected to have a material impact on Websters financial condition or results of operations.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133 (SFAS No. 161). SFAS No. 161 requires enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related items are accounted for under SFAS No. 133 and how derivative instruments and related hedged items affect an entitys financial position, financial performance and cash flows. The new standard is effective for Webster on January 1, 2009. Webster is currently evaluating the impact of adopting SFAS No. 161 on the Consolidated Financial Statements.
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (SFAS No. 162). SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles (GAAP) in the United States (the GAAP hierarchy). The hierarchical guidance provided by SFAS No. 162 did not have an effect on the Companys Consolidated Interim Financial Statements.
NOTE 2: Sale Transactions
On February 1, 2008, Webster completed the sale of Webster Insurance to USI Holdings Corporation. In connection with the sale, Webster Bank entered into a joint marketing arrangement with USI to provide expanded products and services to their respective clients. The sale resulted in the recording of a loss of $2.2 million, net of tax in the first quarter of 2008. A total of $40.4 million of assets held for disposition were transferred to the buyer as well as $6.3 million of liabilities.
On April 22, 2008, Webster announced that a definitive agreement had been reached to sell Webster Risk Services, a third-party workers compensation administrator. A $0.2 million loss, net of tax, was recorded upon completion of the sale on June 30, 2008.
The activities related to Webster Insurance and Webster Risk Services have been reported separately, with current and prior period amounts reclassified as assets and liabilities held for disposition in the Consolidated Balance Sheets and operating results reclassified as discontinued operations in the Consolidated Statements of Operations. Related prior period disclosures in the Notes to the Consolidated Interim Financial Statements have also been revised to incorporate the effect of the discontinued operations. Excluding the $2.4 million loss, net of taxes on the sale of Webster Insurance and Webster Risk Services, the operating results from discontinued operations for both the three and six months ended June 30, 2008 was a loss of $0.2 million, net of taxes.
NOTE 3: Investment Securities
The following table presents a summary of the cost and fair value of Websters securities:
Management evaluates all investments with an unrealized loss in value, whether caused by adverse interest rates, credit movements or some other factor to determine if the loss is other-than-temporary.
The following table provides information on the gross unrealized losses and fair value of Websters investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2008.
The following table provides information on the gross unrealized losses and fair value of Websters investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2007.
The following summarizes, by security type, the basis for the conclusion that the applicable investments within the Companys available for sale portfolio were not other-than-temporarily impaired at June 30, 2008:
The unrealized losses on the Companys investment in corporate bonds and notes increased to $55.6 million at June 30, 2008 after an other-than-temporary impairment charge of $41.6 million for the three and six months ended June 30, 2008. This portfolio consists of various trust preferred securities, both pooled and single issuer, that are at investment grade, below investment grade and unrated. The decline in market value is attributable primarily to changes in interest rates therefore, the Company continues to believe it will collect all scheduled payments. The Company also has the ability and intent to hold these investments until a recovery of fair value, which may be at maturity. As a result, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2008.
The unrealized losses on the Companys investment in equity securities decreased to $3.3 million at June 30, 2008 after an other-than-temporary impairment charges of $12.1 million and $12.6 million for the three and six months ended June 30, 2008, respectively. This portfolio consists primarily of investments in the common and preferred stock of other financial institutions ($47.1 million of the total fair value and $3.3 million of the total unrealized losses) and preferred stock of federal agencies ($14.1 million of the total fair value which approximated cost at June 30, 2008). Estimating the recovery period for equity securities in an unrealized loss position includes analyst forecasts, earnings assumptions and other company specific financial performance metrics. In addition, this assessment incorporates general market data, industry and sector cycles and related trends to determine a reasonable recovery period. The Company evaluated the near-term prospects of the issuers in relation to the severity and duration of the impairment. Based on that evaluation and the Companys ability and intent to hold the investments for a reasonable period of time sufficient for a forecasted recovery of fair value, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2008.
The unrealized losses on the Companys investment in mortgage-backed securities increased to $10.2 million at June 30, 2008. There were no other-than-temporary impairment charges for mortgage-backed securities for the three and six months ended June 30, 2008. The reason for the decline is due to both interest rate and widening credit spreads. The contractual cash flows for these investments are performing as expected. As the decline in market value is attributable to changes in interest rates and credit spreads and not due to underlying credit deterioration, and because the Company has the ability and intent to hold these investments until a recovery of fair value, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2008.
Management also determined that the $560.3 million in held-to-maturity securities that had been in an unrealized loss position for twelve consecutive months or longer were not other-than-temporarily impaired at June 30, 2008. These securities have had varying levels of unrealized loss due to changes in interest rates and spreads since being purchased. At June 30, 2008, the unrealized loss for mortgage-backed securities of $23.7 million was concentrated in seven securities with a total fair value of $541.3 million. These securities carry AAA ratings or Agency-implied AAA credit ratings and are currently performing as expected. The remaining $1.0 million unrealized loss was concentrated in 35 held-to-maturity municipal bonds and notes with a fair value of $19.0 million at June 30, 2008. Most of these bonds and notes are insured AAA rated general obligation bonds with stable ratings. There were no significant credit downgrades since the last review period, and these securities are currently performing as anticipated. 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.
The following table shows the impact of the recognition of other-than-temporary impairments and net realized gains and losses on the sale of securities from the available for sale portfolio for the three and six months ended June 30, 2008 and 2007.
The following summarizes, by security type, the basis for the conclusion that the applicable investments within the Companys available for sale portfolio were other-than-temporarily impaired at June 30, 2008:
Corporate bonds and notes:
Trust preferred securities - the other-than-temporary impairment charge for these securities for the three and six months ended June 30, 2008 was $37.4 million. Approximately $8.5 million was due to an unexpected disruption in expected cash flows due to the increase in the amount of participants in the pool electing to defer interest payments. Based on information received from the securities underwriters and the trustees, it is expected that these securities will resume payments in 2009 and/or 2010. Approximately $28.9 million was due to managements determination that based on the best estimate of cash flows that a market participant would use in determining the current fair value of the beneficial interest, there was an implied adverse change in expected cash flows and accordingly impaired these securities and wrote them down to fair value as of June 30, 2008.
Income notes the other-than-temporary impairment charge for these securities was $4.2 million for the three and six months ended June 30, 2008 due to managements determination that based on the best estimate of cash flows that a market participant would use in determining the current fair value of the beneficial interest, there was an implied adverse change in expected cash flows and accordingly impaired these securities and wrote them down to fair value as of June 30, 2008.
Equity securities the other-than-temporary impairment charge for these securities was $12.1 million and $12.6 million for the three and six months ended June 30, 2008, respectively. The conclusion that these investments were other-than-temporarily impaired was based on managements review of these securities and their prospects for a near term recovery.
To the extent that continued changes in interest rates, credit movements and other factors that influence the fair value of investments occur, the Company may be required to record additional impairment charges for other than temporary impairment in future periods.
NOTE 4: Loans, Net
A summary of loans, net follows:
In 2007, Webster discontinued indirect residential construction lending and indirect home equity lending outside of its primary market area. At December 31, 2007, these two indirect out of market loan portfolios totaling $424.0 million ($340.7 million of indirect home equity products and $83.3 million of residential construction products), were placed into liquidating portfolios, and are currently being managed by a designated credit team. At June 30, 2008, the liquidating portfolios had declined to $373.2 million ($310.4 million of indirect home equity, $46.1 million of residential construction and $16.7 million of 1-4 family residential mortgages).
Financial instruments with off-balance sheet risk
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 instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amount recognized in the Consolidated Balance Sheets.
The following table summarizes financial instruments with off-balance sheet risk:
The interest rates for outstanding loan commitments are generally established shortly before closing. The interest rates on home equity lines of credit adjust with changes in the prime rate. At June 30, 2008, the fair value of financial instruments with off-balance sheet risk are considered insignificant to the financial statements taken as a whole.
NOTE 5: Allowance for Credit Losses
There was significant disruption and volatility in the financial and capital markets during the second half of 2007 and the first half of 2008. Turmoil in the mortgage market adversely impacted both domestic and global markets, and led to a significant credit and liquidity crisis. These market conditions were attributable to a variety of factors; in particular the fallout associated with subprime mortgage loans (a type of lending never actively pursued by Webster). The disruption has been exacerbated by the continued value declines in the real estate and housing market. Webster is not immune to some negative consequences arising from overall economic weakness and, in particular, a sharp downturn in the housing market, both locally and nationally. Decreases in real estate values could adversely affect the value of property used as collateral for loans. Adverse changes in the economy may have a negative effect on the ability of Websters borrowers to make timely loan payments, which would have an adverse impact on the Companys earnings. A further increase in loan delinquencies would decrease net interest income and adversely impact loan loss experience, causing potential increases in the provision and 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 6: Goodwill and Other Intangible Assets
The following tables set forth the carrying values of goodwill and other intangible assets, net of accumulated amortization:
Goodwill is allocated to Websters business segments as follows:
Webster tests its goodwill for impairment annually in its third quarter. Accounting principles generally accepted in the U.S. require additional testing if events or circumstances indicate that impairment may exist. As a result of the continued disruption in the financial markets and the spread between its market capitalization and book value, Webster performed impairment testing of the goodwill for all reporting units as of June 30, 2008. Based upon the impairment testing performed, there was no impairment indicated for Websters goodwill as of June 30, 2008 with the exclusion of its insurance premium financing business. The fair value of this reporting unit was determined utilizing a capitalized earnings approach for valuation purposes. Webster then determined the implied fair value of the reporting units goodwill as compared to its carried balance. Based upon this comparison Webster reduced the carrying value of goodwill by $8.5 million through a charge to second quarter earnings. This charge had no effect on Websters cash balances or liquidity. In addition, as goodwill and other intangible assets are not included in the calculation of regulatory capital, the well-capitalized regulatory ratios of Webster and Webster Bank, N.A., were not affected by this non-cash charge.
A continuing period of market disruption, or further market capitalization deterioration, will result in the requirement to continue to perform testing for impairment between annual assessments. To the extent that additional testing results in the identification of impairment, the Company may be required to record additional charges for the impairment of goodwill.
Amortization of intangible assets for the three and six months ended June 30, 2008, totaled $1.5 million and $3.0 million, respectively. 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 7: Income Taxes
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at June 30, 2008 and December 31, 2007 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.
At June 30, 2008, Websters total amount of unrecognized tax benefits (UTBs), determined under the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes An Interpretation of FASB Statement No. 109 (FIN 48), was $7.1 million. If recognized, $4.3 million of that amount would impact the effective tax rate. During the six months ended June 30, 2008, Websters UTBs decreased by $3.2 million as a result of settlements with taxing authorities.
Additionally, Webster recognizes interest and, where applicable, penalties related to UTBs as a component of income tax expense. During the six months ended June 30, 2008, Webster recognized $0.5 million of interest and penalties and, at June 30, 2008, had accrued interest and penalties related to UTBs of $1.4 million.
Webster has determined it is reasonably possible that its UTBs could decrease within the next 12 months by an amount in the range of $0.5 million to $2.8 million, as a result of potential settlements with state taxing authorities.
NOTE 8: Deposits
The following table summarizes the period end balance and the composition of deposits:
NOTE 9: Federal Home Loan Bank Advances
Advances payable to the Federal Home Loan Bank (FHLB) are summarized as follows:
Webster Bank had additional borrowing capacity from the FHLB of approximately $0.8 billion at June 30, 2008 and $1.2 billion at December 31, 2007. Advances are secured by a blanket security agreement against certain qualifying assets, principally residential mortgage loans. At June 30, 2008 and December 31, 2007, 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, 2008 and December 31, 2007 would have been increased by an additional $758.2 million and $449.6 million, respectively. At June 30, 2008 Webster Bank was in compliance with the FHLB collateral requirements.
NOTE 10: 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:
NOTE 11: Fair Value Measurements
Effective January 1, 2008, Webster adopted the provisions of SFAS No. 157, Fair Value Measurements, for financial assets and financial liabilities. In accordance with FASB Staff Position (FSP) No. 157-2, Effective Date of FASB Statement No. 157, Webster will delay application of SFAS No. 157 for non-financial assets and non-financial liabilities, until January 1, 2009. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in accordance with generally accepted accounting principles and expands disclosures about fair value measurements.
SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability. The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs. An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets and liabilities; it is not a forced transaction. Market participants are buyers and sellers in the principal market that are (i) independent, (ii) knowledgeable, (iii) able to transact and (iv) willing to transact.
SFAS No. 157 requires the use of valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets and liabilities. The income approach uses valuation techniques to convert future amounts, such as cash flows or earnings, to a single present amount on a discounted basis. The cost approach is based on the amount that currently would be required to replace the service capacity of an asset (replacement cost). Valuation techniques should be consistently applied. Inputs to valuation techniques refer to the assumptions that market participants would use in pricing the asset or liability. Inputs may be observable, meaning those that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from independent sources, or unobservable, meaning those that reflect the reporting entitys own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. In that regard, SFAS No. 157 establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all of Websters financial assets and financial liabilities carried at fair value effective January 1, 2008.
In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Valuation adjustments may be made to ensure that financial instruments are recorded at fair value. These adjustments may include amounts to reflect credit quality as well as unobservable parameters. Any such valuation adjustments are applied consistently over time. Websters valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes Websters valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.
Securities Available for Sale. Equity securities and government treasury bills are reported at fair value utilizing Level 1 inputs based upon quoted market prices. Other securities and certain preferred equity securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, Webster obtains fair value measurements from various sources and utilizes matrix pricing to calculate fair value. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury yield curve, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the bonds terms and conditions, among other things. Webster recorded other-than-temporary impairment charges of $53.7 million and $54.2 million, respectively, for the three and six months ended June 30, 2008 reducing the amortized cost of the related available for sale securities. The other-than-temporary charges did not result in a change to the fair value reported in the accompanying Consolidated Balance Sheets.
Trading Securities. Securities classified as trading are reported at fair value utilizing Level 2 inputs in the same manner as described above for securities available for sale.
Derivatives. Derivatives are reported at fair value utilizing Level 2 inputs obtained from third parties to value interest rate swaps and caps. Fair values are compared to independent broker values for reasonableness.
Loans Held for Sale. Loans held for sale are required to be measured at the lower of cost or fair value. Under SFAS No. 157, market value is to represent fair value. As of June 30, 2008, Webster had $4.0 million of loans held for sale. Management obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions. At June 30, 2008, $2.5 million of loans held for sale were recorded at cost and $1.5 million of loans held for sale were recorded at fair value. Webster recorded a mark to market recovery of $4,393 and a charge of $10,278, respectively, to mortgage banking activities in the accompanying Consolidated Statements of Operations for the three and six months ended June 30, 2008.
Impaired Loans. Certain impaired loans are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. When the fair value of the collateral is based on an observable market price or certain appraised values, Webster records the impaired loan using Level 2 inputs. For all other impairments, Webster records the impairment using Level 3 inputs. Loans totaling $44.6 million were deemed impaired at June 30, 2008 and an allowance for loan loss allocation of $14.8 million was made upon identification of impaired loans during the six months ended June 30, 2008.
Servicing Assets. Servicing assets are carried at cost and are subject to impairment testing. Fair value is estimated utilizing market based assumptions for loan prepayment speeds, servicing costs, discount rates and other economic factors. Where the carrying value exceeds fair value a valuation allowance is established through a charge to non-interest income and subsequently adjusted for changes in fair value. For those servicing assets that experienced a change in fair value, Webster reduced its valuation allowance and recorded a valuation allowance recovery of $0.3 million and $0.4 million, respectively, as a component of mortgage banking activities in the accompanying Consolidated Statements of Operations for the three and six months ended June 30, 2008.
The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of June 30, 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
Certain assets and liabilities are measured at fair value on a non-recurring basis in accordance with generally accepted accounting principles. These include assets that are measured at the lower of cost or market that were recognized at fair value below cost at the end of the period as well as assets that are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment).
The following table summarizes financial assets and financial liabilities measured at fair value on a non-recurring basis as of June 30, 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
Non-financial assets and non-financial liabilities measured at fair value on a non-recurring basis include reporting units measured at fair value in the first step of goodwill impairment tests. Non-financial assets and non-financial liabilities measured at fair value in the second step of a goodwill impairment test, and other intangible assets and other non-financial long-lived assets measured at fair value for impairment assessment. As stated above, SFAS No. 157 will be applicable to these fair value measurements beginning January 1, 2009.
Effective January 1, 2008, Webster adopted the provisions of SFAS No. 159, The Fair Value Option for Financial Assets and Financial LiabilitiesIncluding an amendment of FASB Statement No. 115. SFAS No. 159 permits Webster to choose to measure eligible items at fair value at specified election dates. Unrealized gains and losses on items for which the fair value measurement option has been elected are reported in earnings at each subsequent reporting date. The fair value option (i) may be applied instrument by instrument, with certain exceptions, thus Webster may record identical financial assets and liabilities at fair value or by another measurement basis permitted under generally accepted accounting principles, (ii) is irrevocable (unless a new election date occurs) and (iii) is applied only to entire instruments and not to portions of instruments. Adoption of SFAS No. 159 on January 1, 2008 did not have a significant impact on Websters Consolidated Interim Financial Statements as Webster did not elect to report any additional financial assets or financial liabilities at fair value.
NOTE 12: Shareholders Equity
In June 2008, Webster issued 225,000 shares of 8.50% Series A Non-Cumulative Perpetual Convertible Preferred Stock, at $0.01 per share (Series A Preferred Stock). Dividends on the Series A Preferred Stock will be payable quarterly in arrears, when, as and if authorized and declared by Websters board of directors, at an annual rate of 8.50% on the liquidation preference of $1,000 per share of Series A Preferred Stock. The dividend payment dates will be the fifteenth day of each March, June, September and December, commencing on September 15, 2008. Dividends on the Preferred Stock will be non-cumulative; however, with certain limited exceptions, if Webster has not paid or set aside for payment full quarterly dividends on the Series A Preferred Stock for a particular dividend period, Webster may not declare or pay dividends on, or redeem, purchase or acquire, its common stock or other junior securities during the next succeeding dividend period.
Each share of Series A Preferred Stock may be converted at any time, at the option of the holder, into 36.8046 shares of Websters common stock plus cash in lieu of fractional shares, subject to adjustment under certain circumstances. On or after June 15, 2013, if the closing price of Websters common stock exceeds 130% of the then-applicable conversion price for 20 trading days during any 30 consecutive trading day period, including the last trading day of such period, ending on the trading day preceding the date Webster gives notice of conversion, Webster may at its option cause some or all of the Series A Preferred Stock to be automatically converted into Webster common stock at the then prevailing conversion rate. If Webster exercises its right to cause the automatic conversion of Series A Preferred Stock on June 30, 2013, it will still pay any accrued dividends payable on June 15, 2013 to the applicable holders of record.
The shares of Series A Preferred Stock are not subject to the operation of a sinking fund and have no participation rights. The holders of this series have no general voting rights. If any quarterly dividend payable on this series is in arrears for six or more dividend periods (whether consecutive or not), the holders of this series, voting together as a single class with holders of any and all other series of voting preferred stock then outstanding, will be entitled to vote for the election of two additional members of Websters board of directors subject to certain limitations. These voting rights and the terms of any preferred stock directors terminate when Webster has paid in full dividends on this series for at least four consecutive dividend periods following the dividend arrearage.
Accumulated other comprehensive income (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, 2008, 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: Earnings Per Common Share
The following table presents the computation of basic and diluted earnings per share (EPS):
At June 30, 2008 and 2007, options to purchase 2,746,397 and 1,276,514 shares of common stock at exercise prices ranging from $21.88 to $51.31 and $43.67 to $51.31, respectively, were not considered in the computation of potential common shares for purposes of diluted EPS, since the exercise prices of the options were greater than the average market price of Websters common stock for the respective periods.
When computing diluted earnings per share, all potential common stock, including stock options, restricted stock and convertible preferred stock, are anti-dilutive to the earnings per common share calculation. Therefore, for the three and six months ended June 30, 2008 the dilutive effect of these items has not been considered for diluted EPS purposes.
NOTE 15: Business Segments
Webster has four business segments for purposes of reporting segment results. These segments are Commercial Banking, Retail Banking, Consumer Finance and Other. Commercial Banking includes middle market, asset-based lending and commercial real estate. Retail Banking includes retail banking, business and professional banking and investment services. Consumer Finance includes residential mortgage, consumer lending and mortgage banking activities. Other includes equipment financing, investment planning, insurance premium financing, and HSA Bank. The Corporate and reconciling amounts include the Companys Treasury unit, Government Finance, the results of discontinued operations and the amounts required to reconcile profitability metrics to GAAP reported amounts. For further discussion of Websters business segments, see Note 21, Business Segments, on pages 103-105 of Websters 2007 Annual Report on Form 10-K.
The following tables present the operating results and total assets for Websters reportable segments for the three and six months ended June 30, 2008 and 2007. The results for the three and six months ended June 30, 2008 incorporate the allocation of the increased in the provision for loan losses, other-than-temporary impairment charges, goodwill impairment charges and income tax benefit to each of Websters business segments resulting in an increase in the net income of certain business segments as compared to the comparable periods in 2007. For the three and six months ended June 30, 2008, Webster realized an income tax benefit for the effects of the increase in the provision for loan losses and the other-than-temporary impairment of certain available for sale securities. The results for Other for the three and six month periods ended June 30, 2008 include the $8.5 million goodwill impairment charge for the insurance premium financing subsidiary taken in the second quarter of 2008. The impact of this charge was not allocated across all reporting segments.