Webster Financial 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended March 31, 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. x 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 x
The number of shares of common stock outstanding as of April 30, 2008 was 52,489,611.
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 AND COMPREHENSIVE INCOME (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 months ended March 31, 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.
NOTE 2: Purchase and 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. 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. The sale is expected to be completed during the second quarter of 2008. The resulting gain or loss will not be significant to the operating results of Company.
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 Statements of Condition and operating results reclassified as discontinued operations in the Consolidated Statements of Income. Related prior period disclosures in the notes to the consolidated financial statements have also been revised to incorporate the effect of the discontinued operations. Excluding the $2.2 million loss, net of taxes on the sale of Webster Insurance, the operating results from the discontinued operations for the three months ended March 31, 2008 was a gain of $0.1 million, net of taxes.
NOTE 3: Investment Securities
A summary of trading, available for sale and held-to-maturity securities follows:
As of March 31, 2008, the fair value of equity securities consisted of common stock of $42.3 million and preferred stock of $30.2 million. The fair value of equity securities at December 31, 2007 consisted of common stock of $41.0 million and preferred stock of $34.2 million.
During the first quarter of 2008, the Federal Reserve cut the Fed Funds rate by 200 basis points in response to the financial market crisis brought on by the sub prime mortgage concerns, and short term rates declined more than intermediate and long term rates. Credit spreads widened significantly during the first quarter as recession fears and liquidity concerns gripped the market. Although rates on U.S. Treasury securities fell during the first quarter as investors sought the safety of these instruments, yields on credit sensitive fixed income securities were largely higher as investors required more return to take on the credit and liquidity risk of these types of bonds. This development negatively impacted the valuation of the credit sensitive portion of the investment portfolio, specifically corporate bonds and notes. All rated securities are current with their payments and have performed to date as expected. Webster has the intent and ability to hold these securities until full recovery, which may be until maturity.
The following table identifies temporarily impaired investment securities as of March 31, 2008 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, 2007 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 fair 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 evaluates all impairments in value 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; Websters capital, earnings and cash flow positions; and compliance with various debt covenants, among other things. Webster currently intends 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.
Managements evaluation of securities impairment losses at March 31, 2008 began with recognition that market yields continue to be impacted by 6 separate interest rate decreases totaling 300 basis points by the Federal Reserve from September 2007 through March 2008. As of March 31, 2008, the Federal Reserves Open Market Committee has set the federal funds rate target at 2.25%.
Three available for sale corporate bonds totaling $3.4 million at March 31, 2008, had been in an unrealized loss position for twelve consecutive months or longer due to higher interest rates subsequent to their purchase. The Company invests in corporate bonds and notes that are at investment grade, below investment grade and unrated. Valuations for certain corporate bonds and notes are dependant on cash flows from underlying collateral. If unexpected cash flow disruptions occur, other than temporary impairment may result. Bonds and notes that are unrated or below investment grade have undergone internal credit reviews. As a result of credit reviews of the issuers, management has determined that there has been no deterioration in credit quality subsequent to the purchase or last review period. These investments 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.
At March 31, 2008, Webster had $611.7 million in held-to-maturity securities that had been in an unrealized loss position for twelve consecutive months or longer. These securities have had varying levels of unrealized loss due to higher interest rates subsequent to their purchase. At March 31, 2008, approximately 88 percent of the unrealized loss, or $7.2 million, was concentrated in seven mortgage-backed securities held-to-maturity totaling $573.0 million in fair value. These securities carry AAA ratings or Agency-implied AAA credit ratings and are currently performing as expected. The remaining 12 percent, or $1.0 million, of the unrealized loss was concentrated in forty-seven held-to-maturity municipal securities totaling $38.7 million in fair value at March 31, 2008. 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 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.
At March 31, 2008, the company owned equity securities of $43.0 million in common stock and $35.0 million in preferred stock which had fair values of $42.3 million and $30.2 million, respectively. Based on managements review of securities that had been in an unrealized loss position for twelve consecutive months or longer and other factors, the Company recorded $0.5 million in impairment write-downs of equity securities during the three months ended March 31, 2008 compared to no impairment write-downs for the same period in 2007.
NOTE 4: Loans Held for Sale
Loans held for sale had a total carrying value of $8.2 million and $221.6 million at March 31, 2008 and December 31, 2007, respectively. The composition of loans held for sale at March 31, 2008 and December 31, 2007 follows:
At March 31, 2008 and December 31, 2007, residential mortgage origination commitments totaled $6.9 million and $145.8 million, respectively. Residential commitments outstanding at March 31, 2008 consisted of fixed rate mortgages of $6.9 million at rates ranging from 5.38% to 7.5%. Residential commitments outstanding at December 31, 2007 consisted of fixed rate mortgages of $145.8 million at rates ranging from 5.25% to 8.75%. Commitments to originate loans generally expire within 60 days. At March 31, 2008 and December 31, 2007, Webster also had outstanding commitments to sell residential mortgage loans of $13.0 million and $309.9 million, respectively. See Note 16 for a further discussion of loan origination and sale commitments.
The principal reason for the decline is the Companys decision to exit the national wholesale mortgage origination channel in the fourth quarter of 2007.
NOTE 5: Loans, Net
A summary of loans, net follows:
At March 31, 2008, total loans included $16.9 million of net premiums and $44.8 million of net deferred costs, compared with $18.1 million of net premiums and $46.8 million of net deferred costs at December 31, 2007. The unadvanced portions of closed loans totaled $417.5 million and $452.3 million at March 31, 2008 and December 31, 2007, respectively.
At March 31, 2008 and December 31, 2007, unused portions of home equity credit lines related to the continuing portfolio extended were $2.0 billion for both periods. An additional $56.1 million and $65.0 million of unused portions of home equity credit lines were related to loans in the consumer liquidating portfolio at March 31, 2008 and December 31, 2007, respectively. The rates on home equity lines of credit generally vary with the prime rate. Unused commercial lines of credit, letters of credit, standby letters of credit, equipment financing commitments and outstanding commercial loan commitments totaled $2.5 billion at March 31, 2008 and $2.8 billion at December 31, 2007. Other consumer loan commitments totaled $23.8 million and $8.1 million at March 31, 2008 and December 31, 2007, respectively. Rates for these loans are generally established shortly before closing. The estimated fair value of commitments to extend credit is considered insignificant at March 31, 2008 and December 31, 2007.
There was significant disruption and volatility in the financial and capital markets during the second half of 2007 and the first quarter 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 we have never actively pursued). 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 our loans. Adverse changes in the economy may have a negative effect on the ability of our borrowers to make timely loan payments, which would have an adverse impact on our earnings. A further increase in loan delinquencies would decrease our net interest income and adversely impact our loan loss experience, causing potential increases in our provision and allowance for credit losses.
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 totaled $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 managed by a designated credit team. At March 31, 2008, the liquidating portfolios totaled $395.0 million ($326.5 million of indirect home equity and $68.5 million of residential construction).
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. 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 March 31, 2008, Websters stand-by letters of credit totaled $181.3 million. At March 31, 2008, the fair value of stand-by letters of credit is considered insignificant to the 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:
Goodwill is allocated to Websters business segments as follows:
Amortization of intangible assets for the three months ended March 31, 2008, totaled $1.5 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.
As a result of the continued significant disruption in the financial markets, stock prices of many financial services companies (including Commercial banks) continued to decline during the first quarter of 2008. The Company has been affected by these market conditions and its market capitalization was less than book value (shareholders equity) at March 31, 2008. If these conditions and trends continue, the Company may be required to record a charge for the impairment of goodwill.
NOTE 8: Income Taxes
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and liabilities at March 31, 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 March 31, 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 $9.8 million. If recognized, $6.0 million of that amount would impact the effective tax rate. Additionally, Webster recognizes interest and, where applicable, penalties related to UTBs as a component of income tax expense. During the three months ended March 31, 2008, Webster recognized $0.7 million of interest and penalties and, at March 31, 2008, had accrued interest and penalties related to UTBs of $2.9 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 $3.2 to $5.9 million, as a result of potential settlements with state taxing authorities.
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 $1.3 billion from the FHLB at March 31, 2008 and $0.8 billion at December 31, 2007. Advances are secured by a blanket security agreement against certain qualifying assets, principally residential mortgage loans. At March 31, 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 March 31, 2008 and December 31, 2007 would have been increased by an additional $449.6 million and $277.0 million, respectively. At March 31, 2008 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: Fair Value Measurements
Effective January 1, 2008, Webster adopted the provisions of Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, for financial assets and financial liabilities. In accordance with Financial Accounting Standards Board 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.
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 vendors to value its interest rate swaps and caps as well as those of its customers. All bank positions are verified 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 March 31, 2008, Webster has $8.2 million of loans held for sale. Management obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions. Premiums received or to be received on the quotes or bids are indicative of the fact that cost is lower than fair value. At March 31, 2008, $6.4 million of loans held for sale was recorded at its cost. Approximately $1.8 million of loans held for sale were recorded at fair value. Webster recorded a mark to market charge of $14 thousand to mortgage banking activities in the accompanying consolidated statement of income for the three months ended March 31, 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 as Level 2. For all other impairments, Webster records the impairment as Level 3. Loans totaling $24.1 million were deemed impaired and an allowance allocation of $5.9 million was made upon identification of the impaired loans during the quarter ended March 31, 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 gain of $82.5 thousand as a component of its mortgage banking activities in the accompanying consolidated statement of income for the three months ended March 31, 2008.
The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of March 31, 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 nonrecurring 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 March 31, 2008, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
Certain non-financial assets measured at fair value on a non-recurring basis include goodwill, intangible assets, other real estate owned, repossessed assets and other non-financial long-lived assets measured at fair value. 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 principals, (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 financial statements as Webster did not elect to report any additional financial assets or financial liabilities at fair value.
NOTE 13: Shareholders Equity
A total of 7,924 shares of common stock were repurchased during the first three months of 2008 at an average cost of $32.00 per common share. Of the shares repurchased, none were repurchased as part of Websters share repurchase program. At March 31, 2008, there were 2,111,200 shares available to purchase as part of Websters current share repurchase program. A total of 33,049 shares of common stock were repurchased during the first three months of 2007 at an average cost of $47.06 per common share. Of the shares repurchased in the first quarter of 2007, 30,000 were repurchased as part of Websters share repurchase programs. Management may engage in future share repurchases as liquidity conditions permit and market conditions warrant.
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. At March 31, 2008, and 2007, Webster repurchased 7,924 and 3,049 shares respectively, outside of the publicly announced repurchase program.
In September 2006, the EITF reached a final consensus on Issue No. 06-4 (EITF 06-4), Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. EITF 06-4 requires employers to recognize a liability for future benefits provided through endorsement split-dollar life insurance arrangements that extend into postretirement periods in accordance with SFAS No. 106, Employers Accounting for Postretirement Benefits Other Than Pensions or APB Opinion No. 12, Omnibus Opinion 1967. The provisions of EITF 06-4 were effective for Webster on January 1, 2008. Upon adoption of EITF 06-4, Webster established a liability of approximately $0.9 million as a change in accounting principle through accumulative effect adjustment to retained earnings.
Accumulated other comprehensive income (loss) is comprised of the following components:
NOTE 14: 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 March 31, 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 15: Earnings Per Common Share
The following table presents the computation of basic and diluted earnings per share (EPS):
At March 31, 2008 and 2007, options to purchase 1,883,782 and 582,019 shares of common stock at exercise prices ranging from $32.03 to $51.31 and $48.88 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.
NOTE 16: 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, government finance and HSA Bank. The Corporate and reconciling amounts include the Companys Treasury unit, 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:
Three months ended March 31, 2008
Three months ended March 31, 2007
NOTE 17: Derivative Financial Instruments
At March 31, 2008, Webster had outstanding interest rate swaps with a total notional amount of $552.5 million that are designated as hedges of FHLB advances, repurchase agreements and long-term debt (subordinated notes and senior notes). The swaps effectively convert 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, 2007, there were outstanding interest rate swaps with a notional amount of $552.5 million.
Webster transacts certain derivative products with its customer base, primarily interest rate swaps. 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 $417.9 million at March 31, 2008 and $330.4 million at December 31, 2007. 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 March 31, 2008 and December 31, 2007 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 March 31, 2008, outstanding rate locks totaled approximately $6.8 million and the outstanding commitments to sell residential mortgage loans totaled $13.0 million. Forward sales, which include mandatory forward commitments of approximately $8.2 million and best efforts forward commitments of approximately $4.8 million at March 31, 2008, 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 18: Pension and Other Benefits
The following table provides information regarding net benefit costs for the periods shown:
On December 31, 2007, both the Webster Pension Plan and the supplemental pension plan were frozen. Thus, employees will accrue no additional qualified or supplemental retirement benefits after 2007.
Additional 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 Webster Bank Pension Plan in 2008.
As a result of the FIRSTFED acquisition in May 2004, Webster assumed the obligations of the FIRSTFED pension plan. The plan was not merged into the Webster Bank Pension Plan, but instead will continue to be included in the multiple employer plan administered by Pentegra (the Fund). The Fund does not segregate the assets or liabilities of its participating employers in the on-going administration of this plan and accordingly, disclosure of FIRSTFED accumulated vested and nonvested benefits is not possible. Webster estimates it will make approximately $1.4 million in contributions during 2008.
As a result of the acquisition of NewMil Bancorp, Inc. (NewMil) in October 2006, Webster assumed the obligations of the New Milford Savings Bank Defined Benefit Pension Plan. On July 31, 2007, the New Milford Savings Bank Defined Benefit Pension Plan was merged into the Webster Bank Pension Plan.
NOTE 19: Other Comprehensive Income
The following table summarizes the components of other comprehensive income:
NOTE 20: Recent Accounting Pronouncements
In December 2007, the FASB issued revised 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 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 Activitiesan amendment of FASB Statement No. 133. FASB 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 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.
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 March 31, 2008 had assets of $17.2 billion and shareholders equity of $1.7 billion. Websters principal assets are all of the outstanding capital stock of Webster Bank, National Association (Webster Bank). Webster, through Webster Bank and various non-banking financial services subsidiaries, delivers financial services to individuals, families and businesses throughout southern New England and eastern New York State. Webster also offers equipment financing, commercial real estate lending, asset-based lending and insurance premium financing on a regional or national basis. Webster Bank provides commercial banking, retail banking, consumer financing, mortgage banking, trust and investment services through 181 banking offices, 484 ATMs, and its Internet website (www.websteronline.com). Through its HSA Bank division (www.hsabank.com), Webster Bank offers health savings accounts on a nationwide basis. Webster 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 2007 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, 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, 2007 Managements Discussion and Analysis included in the Annual Report on Form 10-K.
RESULTS OF OPERATIONS
Websters net income was $24.4 million, or $.47 per diluted share, for the three months ended March 31, 2008, compared to $35.0 million, or $0.62 per diluted share, for the three months ended March 31, 2007, a decrease of 30.5%. Income from continuing operations was $26.5 million, or $.51 per diluted share, for the three months ended March 31, 2008, compared to $35.1 million, or $0.63 per diluted share for the three months ended March 31, 2007. For the three months ended March 31, 2008, loss from discontinued operations, net of taxes, totaled of $2.1 million, or $.04 per diluted share, compared to a loss, net of taxes of $44 thousand for the three months ended March 31, 2007. The year-over-year decrease in continuing operations is attributable to an increase in the provision for credit losses of $12.8 million and a decrease in net interest income of $3.2 million, which was partially offset by a decrease of $5.0 million in non-interest expenses. The year-over-year comparison of net interest income is impacted by the interest rate environment, and the effect that declining short-term interest rates and a flattening of the yield curve had on the 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. The year-over-year increase in discontinued operations is primarily attributable to expenses related to the sale of Webster Insurance.
Selected financial highlights are presented in the table below.
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 $124.9 million in the first quarter of 2008, which was a decrease of $3.2 million, or 2.5% compared to $128.1 million for the comparable period in 2007.
The decline in net interest income is largely due to the 300 basis point decrease in short-term interest rates over the last year which was partially offset by an increase in the volume of interest-earning assets. For the three months ended March 31, 2008, the yield on interest earning assets decreased 59 basis points due to the decrease in short-term interest rates, while the cost of interest-bearing liabilities declined 47 basis points. As a result, the net interest margin for the three months ended March 31, 2008 was 3.27%, a decrease of 14 basis points from the comparable period in 2007.
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 reported net interest income.
Interest income (on a fully tax-equivalent basis) for the three months ended March 31, 2008 decreased $15.5 million, or 6.2%, from the comparable period in 2007. The decrease in short-term interest rates had an unfavorable impact on interest sensitive loans as well as lower rates on new volumes. The first quarter average balance for securities was $3.0 billion, an increase of $0.5 billion from the comparable period in 2007. The first quarter average balance for loans was $12.5 billion, an increase of $0.1 billion for the comparable period in 2007.
The yield on interest-earning assets decreased 59 basis points for the three months ended March 31, 2008 from the comparable period in 2007. The decrease reflects the declining interest rate environment in these periods.
The loan portfolio yield decreased 66 basis points to 6.08% for the three months ended March 31, 2008 and comprised 80.4% of average interest-earning assets compared to a loan portfolio yield of 6.74% and 81.6% of average interest-earning assets for the three months ended March 31, 2007.
Interest expense for the three months ended March 31, 2008 decreased $13.5 million, or 11.2%, from the comparable period in 2007. The decrease was primarily due to the declining short-term interest rates.
The cost of interest bearing liabilities was 2.82% for the three months ended March 31, 2008, a decrease of 47 basis points compared to 3.29% for the comparable period in 2007. Deposit costs for the three months ended March 31, 2008 decreased to 2.49% from 2.87% for the comparable period in 2007. Total borrowing costs for the three months ended March 31, 2008 decreased 131 basis points to 4.14% from 5.45% for the comparable period in 2007.
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.