Webster Financial 10-Q 2009
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the quarterly period ended June 30, 2009.
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ¨ 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, par value $.01 per share, outstanding as of July 29, 2009 was 68,124,642.
Webster is filing this amended Form 10-Q for the sole and express purpose of correcting an error in the footnote setting forth the cumulative amount of other-than-temporary impairments at June 30, 2009 with respect to the available for sale equity securities portfolio. This amount is set forth in footnote (b) to the first table appearing in Note 4 to the condensed consolidated financial statements included herein.
In addition, as required by Rule 12b-15 under the Securities Exchange Act of 1934, as amended, new certifications by Websters principal executive officer and principal financial officer are filed as exhibits to this Form 10-Q/A under Item 6 hereof. No other new exhibits are being filed herewith.
No other changes have been made to the Form 10-Q. This form 10-Q/A speaks as of the original filing date of the Form 10-Q, does not reflect events that may have occurred subsequent to the original filing date, and does not modify or update in any way disclosures made in the Form 10-Q.
PART I. FINANCIAL INFORMATION
CONDENSED CONSOLIDATED BALANCE SHEETS
See accompanying Notes to Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
See accompanying Notes to Condensed Consolidated Financial Statements.
WEBSTER FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS, continued
See accompanying Notes to Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
See accompanying Notes to Condensed Consolidated Financial Statements.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying Notes to Condensed Consolidated Financial Statements.
WEBSTER FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS, continued
See accompanying Notes to Condensed Consolidated Financial Statements.
WEBSTER FINANCIAL CORPORATION AND SUBSIDIARIES
NOTE 1: Summary of Significant Accounting Policies
Nature of Operations. Webster Financial Corporation (Webster or the Company) is a financial holding company and a bank holding company headquartered in Waterbury, Connecticut that delivers, through its subsidiaries, financial services to individuals, families and businesses throughout southern New England and into eastern New York State. Webster also offers equipment financing, asset-based lending, health savings accounts and insurance premium financing on a national basis and commercial real estate lending on a regional basis.
Basis of Presentation. The condensed consolidated financial statements in this Quarterly Report on Form 10-Q include the accounts of Webster and all other entities in which Webster has a controlling financial interest (collectively referred to as Webster or the Company). All significant intercompany balances and transactions have been eliminated in consolidation. The accounting and financial reporting policies Webster follows conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry.
The condensed consolidated financial statements in this Quarterly Report on Form 10-Q have not been audited by an independent registered public accounting firm, but in the opinion of management, reflect all adjustments necessary for a fair presentation of the Companys financial position and results of operations. All such adjustments were of a normal and recurring nature. The condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (SEC). Accordingly, the condensed consolidated financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements and should be read in conjunction with the Companys consolidated financial statements, and notes thereto, for the year ended December 31, 2008, included in Websters Annual Report on Form 10-K filed with the SEC on March 2, 2009 (the 2008 Form 10-K). Operating results for the interim periods disclosed herein are not necessarily indicative of the results that may be expected for a full year or any future period. Webster has evaluated subsequent events for potential recognition and/or disclosure through August 5, 2009, the date the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q were filed with the SEC.
Use of Estimates. The preparation of the condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements. Actual results could differ from those estimates. The allowance for credit losses, the fair values of financial instruments, the deferred tax asset valuation allowance and the status of goodwill evaluation are particularly subject to change.
Comprehensive Income. Comprehensive income includes all changes in equity during a period, except those resulting from transactions with shareholders. Besides net income, other components of Websters comprehensive income include the after tax effect of changes in the net unrealized gain/loss on securities available for sale, changes in the net actuarial gain/loss on defined benefit post-retirement benefit plans and changes in the accumulated gain/loss on effective cash flow hedging instruments. Comprehensive income for the six months ended June 30, 2009 and 2008 is reported in the accompanying condensed consolidated statements of changes in equity.
Earnings Per Share. Effective January 1, 2009, Webster adopted Financial Accounting Standards Board (FASB) Staff Position (FSP) No. Emerging Issues Task Force Issued No. (ETIF) 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (FSP EITF 03-6-1). FSP EITF 03-6-1 provides that unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. Accordingly, effective January 1, 2009, earnings per common share is computed using the two-class method prescribed by the Statement of Financial Accounting Standards (SFAS) No. (128), Earnings Per Share. (SFAS No. 128) All previously reported earnings or losses per common share information has been retrospectively adjusted to conform to the new computation method.
Reclassifications. Certain items previously reported have been reclassified to conform to the current periods condensed consolidated financial statement presentation.
NOTE 2: New Accounting Standards
Recently Issued Accounting Standards
SFAS No. 166, Accounting for Transfers of Financial Assets, an Amendment of FASB Statement No. 140 (SFAS 166). SFAS 166 amends SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, to enhance reporting about transfers of financial assets, including securitizations, and where companies have continuing exposure to the risks
related to transferred financial assets. SFAS 166 eliminates the concept of a qualifying special-purpose entity and changes the requirements for derecognizing financial assets. SFAS 166 also requires additional disclosures about all continuing involvements with transferred financial assets including information about gains and losses resulting from transfers during the period. SFAS 166 will be effective January 1, 2010 and is not expected to have a significant impact on the Companys condensed consolidated financial statements.
SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (SFAS 167). SFAS 167 amends FASB Interpretation (FIN) No. 46 (FIN 46) FIN 46 (Revised December 2003), Consolidation of Variable Interest Entities, to change how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entitys purpose and design and a companys ability to direct the activities of the entity that most significantly impact the entitys economic performance. SFAS 167 requires additional disclosures about the reporting entitys involvement with variable interest entities and any significant changes in risk exposure due to that involvement as well as its affect on the entitys financial statements. SFAS 167 will be effective January 1, 2010 and is not expected to have a significant impact on the Companys condensed consolidated financial statements.
SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, a Replacement of FASB Statement No. 162(SFAS 168). SFAS 168 replaces SFAS 162, The Hierarchy of Generally Accepted Accounting Principles and establishes the FASB Accounting Standards Codification (the Codification) as the source of authoritative accounting principles recognized by the FASB to be applied by non-governmental entities in the preparation of financial statements in conformity with generally accepted accounting principles. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative guidance for SEC registrants. All guidance contained in the Codification carries an equal level of authority. All non-grandfathered, non-SEC accounting literature not included in the Codification is superseded and deemed non-authoritative. SFAS 168 will be effective for the Companys condensed consolidated financial statements for periods ending after September 15, 2009. SFAS 168 is not expected to have a significant impact on the Companys condensed consolidated financial statements.
Recently Adopted Accounting Standards
SFAS No. 160, Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB Statement No. 51 (SFAS 160). SFAS 160 amends Accounting Research Bulletin (ARB) No. 51, Consolidated Financial Statements, to establish accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 clarifies that a non-controlling interest in a subsidiary, which is sometimes referred to as minority interest, is an ownership interest in the consolidated entity that should be reported as a component of equity in the condensed consolidated financial statements. Among other requirements, SFAS 160 requires condensed consolidated net income to be reported at amounts that include the amounts attributable to both the parent and the non-controlling interest. It also requires disclosure, on the face of the condensed consolidated income statement, of the amounts of condensed consolidated net income attributable to the parent and to the non-controlling interest. SFAS 160 became effective for the Company on January 1, 2009 and did not have a significant impact on the Companys condensed consolidated financial statements.
SFAS No. 161, Disclosures About Derivative Instruments and Hedging Activities, an Amendment of FASB Statement No. 133 (SFAS 161). SFAS 161 amends SFAS 133, Accounting for Derivative Instruments and Hedging Activities, (SFAS 133) to amend and expand the disclosure requirements of SFAS 133 to provide greater transparency about (i) how and why an entity uses derivative instruments, (ii) how derivative instruments and related hedge items are accounted for under SFAS 133 and its related interpretations, and (iii) how derivative instruments and related hedged items affect an entitys financial position, results of operations and cash flows. To meet those objectives, SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about credit-risk-related contingent features in derivative agreements. SFAS 161 became effective for the Company on January 1, 2009 and the required disclosures are reported in Note 17 - Derivative Financial Instruments.
SFAS No. 165, Subsequent Events (SFAS 165). SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or available to be issued. SFAS 165 defines (i) the period after the balance sheet date during which a reporting entitys management should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and (iii) the disclosures an entity should make about events or transactions that occurred after the balance sheet date. SFAS 165 became effective for the Company for periods ending after June 15, 2009. SFAS 165 did not have a significant impact on the Companys condensed consolidated financial statements.
Financial Accounting Standards Board Staff Positions and Interpretations
FSP SFAS 132R-1, Employers Disclosures about Postretirement Benefit Plan Assets (FSP SFAS 132R-1). FSP SFAS 132R-1 provides guidance related to an employers disclosures about plan assets of defined benefit pension or other post-retirement benefit plans. Under FSP SFAS 132R-1, disclosures should provide users of financial statements with an understanding of how investment allocation decisions are made, the factors that are pertinent to an understanding of investment policies and strategies, the major categories of plan assets, the inputs and valuation techniques used to measure the fair value of plan assets, the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period and significant concentrations of risk within plan assets. The disclosures required by FSP SFAS 132R-1 will be included in the Companys consolidated financial statements beginning with the financial statements for the year-ended December 31, 2009.
FSP SFAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (FSP SFAS 157-4). FSP SFAS 157-4 affirms that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction, and clarifies and includes additional factors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active. FSP SFAS 157-4 requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence. FSP SFAS 157-4 also amended SFAS 157, Fair Value Measurements, to expand certain disclosure requirements. The Company adopted the provisions of FSP SFAS 157-4 during the second quarter of 2009. Adoption of FSP SFAS 157-4 did not significantly impact the Companys condensed consolidated financial statements.
FSP SFAS 115-2 and SFAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (FSP SFAS 115-2 and SFAS 124-2). FSP SFAS 115-2 and SFAS 124-2 (i) changes existing guidance for determining whether an impairment is other-than-temporary to debt securities and (ii) replaces the existing requirement that the entitys management assert it has both the intent and ability to hold an impaired security until recovery with a requirement that management assert: (a) it does not have the intent to sell the security; and (b) it is more likely than not it will not have to sell the security before recovery of its cost basis. Under FSP SFAS 115-2 and SFAS 124-2, declines in the fair value of held-to-maturity and available for sale securities below their cost that are deemed to be other-than-temporary are reflected in earnings as realized losses to the extent the impairment is related to credit losses. The amount of the impairment related to other factors is recognized in other comprehensive income. The Company adopted the provisions of FSP SFAS 115-2 and SFAS 124-2 during the second quarter of 2009. Adoption of FSP SFAS 115-2 and SFAS 124-2 resulted in the reclassification of $17.6 million ($11.4 million, net of tax) of non-credit related OTTI to OCI which had previously been recognized in earnings and is disclosed in Note 4 - Investment Securities.
FSP SFAS 107-1 and Accounting Principles Board Opinion No. (APB 28-1), Interim Disclosures about Fair Value of Financial Instruments. (FSP SFAS 107-1 and APB 28-1) FSP SFAS 107-1 and APB 28-1 amends SFAS 107, Disclosures about Fair Value of Financial Instruments, (SFAS 107) to require an entity to provide disclosures about the fair value of financial instruments in interim financial information and amends APB 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. The new interim disclosures required by FSP SFAS 107-1 and APB 28-1 are included in Note 12 - Fair Value Measurements.
FSP SFAS 141R-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies. (FSP SFAS 141R-1). FSP SFAS 141R-1 amends the guidance in SFAS 141R to require that assets acquired and liabilities assumed in a business combination that arise from contingencies be recognized at fair value if fair value can be reasonably estimated. If fair value of such an asset or liability cannot be reasonably estimated, the asset or liability would generally be recognized in accordance with SFAS 5, Accounting for Contingencies, and FIN No. 14, Reasonable Estimation of the Amount of a Loss. FSP SFAS 141R-1 removes subsequent accounting guidance for assets and liabilities arising from contingencies from SFAS 141R and requires entities to develop a systematic and rational basis for subsequently measuring and accounting for assets and liabilities arising from contingencies. FSP SFAS 141R-1 eliminates the requirement to disclose an estimate of the range of outcomes of recognized contingencies at the acquisition date. For unrecognized contingencies, entities are required to include only the disclosures required by SFAS 5. FSP SFAS 141R-1 also requires that contingent consideration arrangements of an acquiree assumed by the acquirer in a business combination be treated as contingent consideration of the acquirer and should be initially and subsequently measured at fair value in accordance with SFAS 141R. FSP SFAS 141R-1 is effective for assets or liabilities arising from contingencies the Company acquires in business combinations occurring after January 1, 2009.
NOTE 3: Subsequent Events
On July 27, 2009, Webster announced that Warburg Pincus (Warburg), the global private equity firm agreed to invest $115 million in Webster through a direct purchase of newly issued shares of common stock, junior non-voting preferred stock, and warrants. Warburg is acquiring 11.5 million shares of common stock from Webster, upon receipt of all necessary approvals. Warburg initially funded approximately $40.2 million of its investment and received approximately 4 million shares of common stock and 3 million warrants. Upon initial funding, Warburg will have a 5.9 percent ownership of Websters common stock outstanding prior to bank regulatory and shareholder approvals. Warburg will fund the remaining $74.8 million and be issued the remaining common stock, junior non-voting preferred stock, and warrants, following receipt of necessary antitrust and federal bank regulatory approvals.
Following the funding of the remaining portion, Warburg will have a 15.2 percent ownership of Websters common stock outstanding. A portion of Warburgs investment that is funded following the receipt of regulatory approvals will initially be held in the form of junior non-voting preferred stock which will automatically convert into Webster common stock upon receiving the requisite approval of Websters shareholders. The preferred stock initially will have a dividend that mirrors any dividend payable on the common stock. If the requisite shareholder approval is not received, and the preferred shares are therefore still outstanding after February 28, 2010, the preferred stocks annual non-cumulative dividend will increase to 8 percent per annum. The preferred stock is expected to qualify for Tier I capital treatment.
As part of the transaction, Warburg will receive 8.6 million seven-year Class A Warrants. The Class A Warrants will initially have a strike price of $10.00 per share, with the strike price increasing to $11.50 per share twenty four months after this transaction and to $13.00 per share forty eight months after this transaction. Warburg also will receive 5.5 million seven-year Class B Warrants with a strike price of $2.50 per share which will only become exercisable and transferable if, following the receipt of necessary regulatory approvals, shareholder approval is not received by February 28, 2010. The Class B Warrants will expire immediately upon receiving shareholder approval.
The investment held by Warburg including the exercise of the Class A and Class B warrants is subject to Warburg not owning more than 23.9% of Websters voting securities as calculated under applicable regulations of the Board of Governors of the Federal Reserve System.
Subsequent events have been evaluated through August 5, 2009, the date financial statements are filed with the SEC. Through that date, except for the transaction previously discussed, there were no additional events requiring disclosure.
NOTE 4: Investment Securities
The following table presents a summary of the cost and fair value of Websters investment securities. For securities classified as available for sale, the following table shows the unrealized gains and losses (pre-tax) in accumulated other comprehensive income, by security type.
Management evaluates all investment securities 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 investment securities with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment security category and length of time that individual investment securities have been in a continuous unrealized loss position at June 30, 2009.
The following table provides information on the gross unrealized losses and fair value of Websters investment securities with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment security category and length of time that individual investment securities have been in a continuous unrealized loss position at December 31, 2008.
Management conducts a formal review of investment securities on a quarterly basis for the presence of other-than-temporary impairment (OTTI). For the second quarter of 2009, Webster adopted FSP SFAS 115-2 and SFAS 124-2, issued by the FASB on April 9, 2009. Management assesses whether OTTI is present when the fair value of a debt security is less than its amortized cost basis at the balance sheet date. Under these circumstances as required by the new FSP, OTTI is considered to have occurred (1) if Webster intends to sell the security; (2) if it is more likely than not that Webster will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. The more likely than not criteria is a lower threshold than the probable criteria used under previous guidance.
The FSP requires that credit-related OTTI is recognized in earnings while non-credit related OTTI on securities not expected to be sold is recognized in other comprehensive income (OCI). Non-credit related OTTI is caused by other factors, including illiquidity. For securities classified as held-to-maturity (HTM), the amount of OTTI recognized in OCI is accreted to the credit-adjusted expected cash flow amounts of the securities over future periods. Non-credit related OTTI recognized in earnings previous to April 1, 2009 is reclassified from retained earnings to accumulated OCI as a cumulative effect adjustment. The Company adopted this FSP effective April 1, 2009. The adoption of this FSP resulted in the reclassification of $17.6 million, ($11.4 million, net of tax) of non-credit related OTTI to OCI which had previously been recognized in earnings.
As stated in Websters 2008 Annual Report on Form 10-K, managements OTTI evaluation process also follows the guidance of SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, EITF 99-20, Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets, and FSP No. EITF 99-20-1, Amendments to the Impairment and Interest Income Measurement Guidance of EITF Issue No. 99-20 (FSP EITF 99-20-1). This guidance requires the Company to take into consideration current market conditions, fair value in relationship to cost, extent and nature of change in fair value, issuer rating changes and trends, volatility of earnings, current analysts evaluations, all available information relevant to the collectability of debt securities, Websters ability and intent to hold investments until a recovery of fair value, which may be maturity, and other factors when evaluating for the existence of OTTI in its securities portfolio. FSP EITF 99-20-1 was issued on January 12, 2009 and is effective for reporting periods ending after December 15, 2008. This FSP amends EITF 99-20 by eliminating the requirement that a holders best estimate of cash flows be based upon those that a market participant would use. Instead, the FSP requires that OTTI be recognized as a realized loss through earnings when there has been an adverse change in the holders expected cash flows such that it is probable that the full amount will not be received. This requirement is consistent with the impairment model in SFAS 115.
In addition, the disclosure and related discussion of unrealized losses is presented pursuant to FSP FAS 115-1 and FAS 124-1, (EITF 03-1) and EITF Issue No. 03-1, The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments (ETIF 03-1). FSP FAS 115-1 and FAS 124-1 replaces certain impairment evaluation guidance of EITF 03-1; however, the disclosure requirements of EITF 03-1 remain in effect. This FSP addresses the determination of when an investment is considered impaired, whether the impairment is considered to be other-than-temporary, and the measurement of an impairment loss. The FSP also supersedes EITF Topic No. D-44, Recognition of Other-Than-Temporary Impairment upon the Planned Sale of a Security Whose Cost Exceeds Fair Value, and clarifies that an impairment loss should be recognized no later than when the impairment is deemed other-than-temporary, even if a decision to sell an impaired security has not been made.
For the three and six months ended June 30, 2009, Webster recognized OTTI of $27.1 million. The OTTI charge was comprised of a credit related OTTI charge of $23.6 million for certain pooled trust preferred securities and a $3.5 million OTTI charge on an equity security. OTTI charges were recognized in earnings for these securities as management concluded that it is more likely than not that the security will be sold before recovery of the cost basis in the security.
For all security types discussed below where no OTTI is considered necessary at June 30, 2009, management applied the criteria of FSP FAS 115-2 and FAS 124-1 to each investment individually. That is, for each security evaluated, management concluded that it does not intend to sell the security and it is not more likely than not that management will be required to sell the security before recovery of its amortized cost basis and as such OTTI was not recognized in earnings.
The following summarizes, by investment security type, the basis for the conclusion that the applicable investment securities within the Companys available for sale portfolio were not other-than-temporarily impaired at June 30, 2009:
Corporate bonds and notes
The unrealized losses on the Companys investment in corporate bonds and notes decreased to $34.2 million at June 30, 2009 from $66.1 million at December 31, 2008. This portfolio consists of various trust preferred securities, both pooled and single issuers, that are investment grade, below investment grade and unrated.
Single IssuerThe single issuer trust preferred portfolio totals $31.7 million in total fair value and accounts for $23.9 million of the total unrealized losses at June 30, 2009. The single issuer portfolio consists mainly of three large cap, money center financial institutions and one mid-size regional financial institution. During the quarter, two of the issuers were downgraded. However impairment was not warranted due to the issuers continued ability to service their debt and indications of stabilization in their capital structures, as evidenced by the U.S. Treasurys purchase of CPP preferred stock in each institution. Unrealized losses for these institutions was $9.8 million at June 30, 2009
Pooled Trust Preferred SecuritiesThe pooled trust preferred portfolio totals $83.0 million in total fair value and accounts for $10.3 million of the total unrealized losses at June 30, 2009. The pooled trust preferred portfolio consists of various classes in fifteen CDOs containing predominantly bank and insurance collateral. The unrealized loss is attributable primarily to changes in interest rates, including a liquidity spread premium to reflect the inactive and illiquid nature of the trust preferred securities market at this time. To determine expected credit losses, management compared amortized cost to the present value of cash flows adjusted for deferrals and defaults using the purchased discount margin. Other factors considered include an analysis of excess subordination and temporary interest shortfall coverage. Based on the valuation analysis as of June 30, 2009 management expects to fully recover amortized cost. However, additional interest deferrals and /or defaults could result in future other than temporary impairment charges. See Note 12 Fair Value Measurements for additional information on pooled trust preferred securities.
The Company does not consider these investments to be other-than-temporarily impaired at June 30, 2009.
The unrealized losses on the Companys investment in equity securities decreased to $1.3 million at June 30, 2009 from $2.2 million at December 31, 2008 after the other-than-temporary impairment charge of $3.5 million for the three and six months ended June 30, 2009. This portfolio consists primarily of investments in the common stock of small capitalization financial institutions based in New England ($12.1 million of the total fair value and $1.3 million of the total unrealized losses at June 30, 2009), auction rate preferred securities ($2.0 million of the total fair value at June 30, 2009), perpetual preferred stock of government sponsored enterprises (GSE) ($0.5 million of the total fair value at June 30, 2009), and perpetual preferred stock of a non-public financial institution (which during the quarter was deemed other-than-temporary impaired and has no fair value at June 30, 2009). When estimating the recovery period for equity securities in an unrealized loss position, management utilizes 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, management does not have the intent to sell the security and it is more likely than not it will not have to sell the security before recovery of its cost basis. The Company does not consider these investments to be other-than-temporarily impaired at June 30, 2009. For its investments in perpetual preferred stock, Webster evaluates these securities for other-than-temporary impairment using an impairment analysis that is applied to debt securities, which is consistent with SEC guidance.
Mortgage-backed securities (GSE) The unrealized losses on the Companys investment in residential mortgage-backed securities issued by the GSEs increased to $2.1 million at June 30, 2009 from $0.2 million at December 31, 2008. 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 not due to underlying credit deterioration, and because management does not have the intent to sell the security, and it is more likely than not it will not have to sell the security before recovery of its cost basis, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2009.
Mortgage-backed securities (other) The unrealized losses on the Companys investment in commercial mortgage-backed securities issued by entities other than GSEs decreased to $53.3 million at June 30, 2009 from $60.2 million at December 31, 2008. 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 not due to underlying credit deterioration, and because management does not have the intent to sell the security, and it is more likely than not it will not have to sell the security before recovery of its cost basis, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2009.
The following summarizes by investment security type the basis for the conclusion that the applicable investment securities within the Companys held-to-maturity portfolio were not other-than-temporarily impaired at June 30, 2009:
Municipal bonds and notes The unrealized losses on the Companys investment in municipal bonds and notes increased to $17.0 million at June 30, 2009 from $14.5 million at December 31, 2008. Approximately $14.3 million of the $17.0 million unrealized losses at June 30, 2009 had been in an unrealized loss position for twelve consecutive months or longer as compared to $3.9 million of the $14.5 million at December 31, 2008. These securities are primarily insured AA and A rated general obligation bonds with stable ratings. The $14.3 million unrealized loss was concentrated in 221 municipal bonds and notes with a fair value of $223.4 million. Management does not have the intent to sell the security, and it is more likely than not it will not have to sell the security before recovery of its cost basis. The Company does not consider these investments to be other-than-temporarily impaired at June 30, 2009.
Mortgage-backed securities-(GSE) The unrealized losses on the Companys investment in residential mortgage-backed securities issued by the GSEs increased $5.6 million at June 30, 2009. 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 not due to underlying credit deterioration, and because management does not have the intent to sell the security and it is more likely than not it will not have to sell the security before recovery of its cost basis, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2009.
Mortgage-backed securities-(other) The unrealized losses on the Companys investment in residential mortgage-backed securities issued by entities other than GSEs decreased to $1.1 million at June 30, 2009 from $1.8 million at December 31, 2008. Approximately $1.1 million at June 30, 2009 had been in an unrealized loss position for twelve consecutive months or longer as compared to $1.8 million at December 31, 2008. These securities carry AAA ratings and are currently performing as expected. The $1.1 million unrealized loss was concentrated in three securities with a total fair value of $60.1 million. Management does not have the intent to sell the security, and it is more likely than not it will not have to sell the security before recovery of its cost basis. The Company does not consider these investments to be other-than-temporarily impaired at June 30, 2009.
There were no significant credit downgrades on these held-to-maturity securities during the second quarter of 2009, and they are currently performing as anticipated. Management does not consider these investments to be other-than-temporarily impaired and management does not have the intent to sell the security, and it is more likely than not it will not have to sell the security before recovery of its cost basis. Management expects that recovery of these temporarily impaired securities will occur over the weighted-average estimated remaining life of these securities.
The amortized cost and fair value of securities at June 30, 2009, by contractual maturity, are set forth below. Actual maturities may differ from contractual maturities because certain borrowers have the right to call or prepay obligations with or without call or prepayment penalties.
For the three and six months ended June 30, 2009 and 2008, proceeds from the sale of available for sale securities were $8.0 million and $410.3 million and $4.8 million and $6.3 million, respectively. The following tables summarize the impact of the recognition of other-than-temporary impairments and net realized gains and losses on sales of securities for the three and six months ended June 30, 2009.
To the extent that changes in interest rates, credit movements and other factors that influence the fair value of investments occur, the Company may be required to record impairment charges for other-than-temporary impairment in future periods. See pages 84-89 of Websters 2008 Annual Report on Form 10-K for additional information regarding other-than-temporary impairment charges taken by the Company for the year ended December 31, 2008.
The following is a roll forward of the amount of credit related OTTI recognized in earnings:
See Note 12 - Fair Value Measurements for additional information related to the fair value of financial instruments held by Webster as of June 30, 2009.
NOTE 5: Loans, Net
A summary of loans, net follows:
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 condensed 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, 2009, the fair value of financial instruments with off-balance sheet risk is considered insignificant to the condensed consolidated financial statements taken as a whole.
NOTE 6: Allowance for Credit Losses
The disruption and volatility in the domestic and global financial and capital markets that began in 2008 continued to affect the banking industry through the second quarter of 2009. There continues to be rising unemployment, a substantial increase in delinquencies, limited refinancing options, and continued declining real estate values. 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 increase loan losses, causing potential increases in the provision and allowance for credit losses.
The allowance for credit losses is maintained at a level that management believes is 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 is 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:
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. A continuing period of market disruption, or further market capitalization to book value deterioration, may result in the requirement to continue to perform testing for impairment between annual assessments. Management will continue to monitor the relationship of the Companys market capitalization to its book value, which management attributes primarily to financial services industry-wide factors and to evaluate the carrying value of goodwill. To the extent that testing results in the identification of impairment, the Company may be required to record charges for the impairment of goodwill. Management did not perform any additional testing during the first half of 2009, but continues to monitor market conditions. For additional information regarding the valuation of goodwill and impairment charges recorded for the year ended December 31, 2008, see pages 94-95 of Websters 2008 Annual Report on Form 10-K.
Amortization of intangible assets for the three and six months ended June 30, 2009, totaled $1.4 million and $2.9 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 8: Deposits
The following table summarizes the period end balance and the composition of deposits:
Interest expense on deposits is summarized as follows:
NOTE 9: Federal Home Loan Bank Advances
Advances payable to the Federal Home Loan Bank (FHLB) are summarized as follows:
Webster Bank National Association (Webster Bank) had additional borrowing capacity from the FHLB of approximately $2.0 billion at June 30, 2009 and $1.6 billion at December 31, 2008. Advances are secured by a blanket lien against certain qualifying assets, principally residential mortgage loans. At June 30, 2009 and December 31, 2008, 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, 2009 and December 31, 2008 would have been increased by an additional $1.6 billion and $1.0 billion, respectively. At June 30, 2009 and December 31, 2008, Webster Bank was in compliance with applicable 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:
The following table sets forth certain information on short-term repurchase agreements:
NOTE 11: Long-Term Debt
On March 10, 2009, the Company announced the commencement of a fixed price cash tender offer, which expired on March 18, 2009, for any and all of Webster Banks outstanding 5.875% Subordinated Notes due in 2013. The consideration paid per $1,000 of principal was $800 plus all accrued and unpaid interest. Holders tendered $22.5 million of the outstanding principal of the subordinated debt for a total payment of $18.3 million including $0.2 million of accrued interest, resulting in a $4.3 million gain. In connection with the tender offer, the Company terminated $25 million of the fair value hedge associated with the subordinated notes. The termination of that portion of the swap resulted in a net gain of $1.9 million. Both the net gain from the tender offer and the termination of the fair value hedge were recorded in the three months ended March 31, 2009. The pro-rata share of the gain not directly related to the debt redemption was $188,480 which was deferred and is being amortized over the remaining life of the subordinated notes. A total gain of $6.2 million was recognized in the accompanying condensed consolidated statement of operations for the six months ended June 30, 2009.
On May 28, 2009, the Company announced the commencement of an exchange offer, which expired on June 24, 2009, with holders of Websters 8.50% Series A Non-Cumulative Perpetual Convertible Preferred Stock (the Series A Preferred Stock) and Webster Capital Trust IVs 7.65% Fixed to Floating Rate Trust Preferred Securities (the Trust Preferred Securities). See Note 13 Shareholders Equity for additional information related to the effect of the exchange offer on the Series A Preferred Stock.
The Company offered 82.0755 shares of its common stock plus accrued distributions in exchange for each $1,000 liquidation amount of the Trust Preferred Securities. Following the exchange, the Trust Preferred Securities held by Webster were used to liquidate Websters junior subordinated debentures of Webster Capital Trust IV. The exchange resulted in the liquidation of $63.9 million of Webster Capital Trust IVs junior subordinated debentures and the issuance of 5.2 million shares of common stock at a fair value of $36.7 million net of issuance costs. The extinguishment of the Trust Preferred Securities resulted in the recognition of a $24.3 million net gain in the accompanying condensed consolidated statement of operations for the three and six months ended June 30, 2009.
NOTE 12: Fair Value Measurements
SFAS No. 157, Fair Value Measurements (SFAS 157) establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
A description of the valuation methodologies used for financial instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
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. Any investment security not valued based upon the methods previously discussed are considered Level 3. The Level 3 fair values are determined using unobservable inputs and included pooled trust preferred securities transferred to Level 3 in the third quarter of 2008. The market for pooled trust preferred securities has been relatively inactive for several quarters as secondary trading in these securities has dropped to a fraction of the levels experienced prior to the current financial market disruption. There has been no new issuance of pooled trust preferred securities since 2007 and few market participants willing or able to transact in these securities. Management utilizes an internally developed model to fair value the pooled trust preferred securities. The model utilizes certain assumptions which management evaluates for reasonableness. Management evaluates various factors for pooled trust preferred securities, including actual and estimated deferral and default rates that are implied from the underlying performance of the issuers in the structure. Contractual cash flows are reduced by both actual and expected deferrals and defaults and discounted at a rate that incorporates both liquidity and credit risk by credit rating to determine the fair market value of each security. Discount rates are implied from observable and unobservable inputs. The uncertainty in evaluating the credit risk in these securities required the Company to consider and weigh various inputs (see Note 4 for additional information).
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 other independent third party values for reasonableness.
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 $587.2 million were deemed impaired at June 30, 2009. At June 30, 2009 $483.1 million were reported at amortized cost and $104.1 million was reported at fair value. At June 30, 2009 a valuation allowance of $23.0 million was maintained for loans reported at fair value.
Loans Held for Sale. Loans held for sale are required to be carried at the lower of cost or fair value. Under SFAS 157, market value is to represent fair value. As of June 30, 2009, Webster had $113.9 million of loans held for sale. Management obtains quotes or bids on all or part of these loans directly from the purchasing financial institutions which are considered to be Level 2 inputs. At June 30, 2009, $68.6 million of loans held for sale were recorded at cost and $45.3 million of loans held for sale were recorded at fair value.
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 which are considered to be Level 3 inputs. 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 $17,350 and $85,792 as a component of mortgage banking activities in the accompanying condensed consolidated statements of operations for the three and six months ended June 30, 2009.
The following table summarizes financial assets and financial liabilities measured at fair value on a recurring basis as of June 30, 2009, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
The following table shows a reconciliation of the beginning and ending balances for Level 3 assets for the three and six months ended June 30, 2009:
For the three and six months ended June 30, 2009 the change in the unrealized loss on investments held as of June 30, 2009 was $20.9 million and $40.6 million, respectively, after the impact of net credit related OTTI charges.
Certain assets and liabilities are measured at fair value on a non-recurring basis in accordance with GAAP. 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, 2009, 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 foreclosed assets (upon initial recognition or subsequent impairment), non-financial assets and non-financial liabilities measured at fair value in the second step of a goodwill impairment test, and intangible assets and other non-financial long-lived assets measured at fair value for impairment assessment.
Foreclosed property and repossessed assets consists of loan collateral which has been repossessed through foreclosure. This collateral is comprised of commercial and residential real estate and other non-real estate property, including equipment and vehicles. Foreclosed property and repossessed assets are recorded as held for sale initially at the lower of the loan balance or fair value of the collateral less estimated selling costs. For the three and six months ended June 30, 2009, foreclosed properties and repossessed assets with a fair value of $11.0 million and $21.3 million were transferred to foreclosed property and repossessed assets from loans. Prior to the transfer, the assets were written down to fair value through a charge to the allowance for loan losses. For the three and six months ended June 30, 2009, valuation adjustments to reflect foreclosed properties and repossessed assets at fair value less cost to sell resulted in a charge to the allowance for loan losses of $2.6 million and $4.8 million, respectively. Subsequent to foreclosure, valuations are updated periodically, and the assets may be marked down further, reflecting a new cost basis. Subsequent valuation adjustments to foreclosed properties and repossessed assets totaled $2.8 million and $6.3 million, respectively, reflective of continued deterioration in market values. Fair value measurements may be based upon appraisals or third-party price opinions and, accordingly, those measurements are classified as Level 2. Other fair value measurements may be based on internally developed pricing methods, and those measurements are classified as Level 3.
SFAS 107 requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. A detailed description of the valuation methodologies used in estimating the fair value of financial instruments is set forth in the 2008 Form 10-K.