Webster Financial - Q2 2023
July 20, 2023
Transcript
Operator (participant)
Good morning. Welcome to the Webster Financial Corporation Second Quarter 2023 Earnings Call. Please note, this event is being recorded. I would now like to introduce Webster's Director of Investor Relations, Emlen Harmon, to introduce the call. Mr. Harmon, please go ahead.
Emlen Harmon (Director of Investor Relations)
Good morning. Before we begin our remarks, I want to remind you that the comments made by management may include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and are subject to the Safe Harbor rules. Please review the forward-looking disclaimer and Safe Harbor language in today's press release and presentation for more information about risks and uncertainties which may affect us. The presentation and accompanying management's remarks can be found on the company's investor relations website at investors.websterbank.com. I'll now turn it over to Webster Financial CEO, John Ciulla.
John Ciulla (CEO)
Thanks, Emlen. Good morning, and welcome to Webster Financial Corporation's Second Quarter 2023 Earnings Call. We appreciate you joining us this morning. I'll provide remarks on our high-level results and operations before turning it over to Glenn to cover our financial results in greater detail. Webster's results in the quarter illustrate the competitive advantages of our funding profile. While we experienced some temporary NIM headwinds as we pulled liquidity onto our balance sheet early in the quarter, overall, our diverse and distinctive deposit gathering channels provided steady funding as we grew deposits significantly and increased our off-balance sheet liquidity. Glenn will provide more specific detail on balance sheet trends in his remarks. In the face of industry challenges, we are proud of our financial performance in the quarter. On an adjusted basis, we generated EPS of $1.50.
While we saw a modest 1.9% quarter-over-quarter decline in Net Interest Income, we anticipate a positive trajectory through the remainder of the year. Our other income statement lines exhibited positive trends as we grew non-interest income and maintained flat expenses. Despite maintaining a higher than normal liquidity position, we generated an adjusted ROA at just under 1.4% and an adjusted return on Tangible Common Equity of 20.4%. We grew our deposits by over 6% in the quarter. Our robust funding profile positioned us to continue to serve our clients, and we grew our loan book by 1.4%. Our strong deposit growth allowed us to reduce our loan-to-deposit ratio to 88%, which provides us balance sheet flexibility as we move forward.
If you turn to Slide 3, I want to reemphasize the unique funding model that enabled this performance. We have a diverse set of deposit-generating businesses, each with distinct client dynamics. This model provides us with a funding advantage, as characteristics of the various businesses partially mitigate the effects of general industry deposit outflows. While we are not immune to the higher funding costs the banking industry is experiencing, we like our competitive positioning on that front, and we have the ability to grow core deposits through environments in which others are challenged. Our consumer deposits are largely originated in footprint to long-tenured clients. Our $8 billion+ of HSA deposits are all in individual customer accounts, and nearly all are within FDIC insurance limits. As most of you are aware, this is a particularly unique source of low-cost and long-duration deposits.
Within commercial banking, we have $2 billion of business banking deposits that share similar characteristics to the consumer book. The remainder of commercial deposits are diverse by industry, customer type, and geography, and are aligned with our relationship banking model. Finally, interLINK, a platform we acquired earlier this year, provides readily available core deposit funding at a low cost of acquisition, with nearly all deposits covered by FDIC insurance. On Slide 4, you can see that not only did we grow deposits smartly, but immediately available liquidity also increased to $18 billion, which covers just under 125% of our uninsured and uncollateralized deposits. Our balance sheet remains in exceptionally sound condition. As Glenn will discuss further on subsequent slides, things remain stable from an overall credit perspective.
While we do not see any significant signs of broad credit weakness, we continue to act prudently and proactively with respect to managing our existing loan portfolio and onboarding new credit, given the existing macro uncertainties. I want to once again touch briefly on our office portfolio. You can see that on slide five, as that has continued, I know, to be an area of market focus. We have proactively reduced the size of our non-medical office portfolio, which is now down by almost $400 million over the last year, or roughly 25%. We've done so without incurring significant losses, as our charge-off rate on this relatively small portion of the office portfolio is under 2% on an annualized basis.
The overall credit characteristics of this portfolio have not changed materially, as you can see in the figures we provide on LTVs, debt service coverage, and other metrics. While our criticized and classified loans are up modestly from last quarter, they are down relative to fourth quarter and the year ago period, given the proactive actions we've taken. Consistent with my comments above, while we are pleased with performance to date, we fully appreciate the changing dynamics in commercial real estate, and we continue to manage our portfolios and credit selection accordingly and prudently. I'll now turn it over to Glenn to provide more details on the quarter.
Glenn McInnes (CFO)
Thanks, John. Good morning, everyone. I'll start on Slide 6 with our GAAP and adjusted earnings. We reported GAAP net income to common shareholders of $231 million, earnings per share of $1.32. On an adjusted basis, we reported net income to common shareholders of $261 million and EPS of $1.50, excluding one-time merger-related expense of $30 million. Merger expenses were primarily related to professional fees, severance, and technology costs. I'll review our balance sheet trends, beginning on slide 7. Total assets were $74 billion at period end, down $800 million from the first quarter, largely as a result of shifting from on-balance sheet cash to off-balance sheet liquidity sources. At quarter end, we held $1 billion in cash on the balance sheet, which approximates the level of cash we anticipate holding going forward.
Loan growth was $700 million, principally driven by commercial banking. Our security balances were relatively flat in the quarter, as were reinvested proceeds from maturities and sales. Deposits grew $3.5 billion in the quarter, and we reduced our borrowings by more than $4 billion. Deposit growth was achieved despite a $700 million seasonal decline in public funds quarter-over-quarter. As a result of the loan and deposit growth, our loan-to-deposit ratio was 88% at quarter end, down from 92% in the prior quarter. Our capital levels remain strong. Common Equity Tier 1 ratio was 10.66%, and our Tangible Common Equity ratio was 7.23%. Tangible book value increased to $29.69 a share, with retained earnings exceeding the impact of AOCI and a small share repurchase.
Unrealized security losses, including intangible book value, increased to $645 million after tax from $560 million last quarter, driven by higher rates. In a steady interest rate environment, we anticipate roughly $100 million of this will accrete back into capital annually. Loan trends are highlighted on slide 8. Total, we grew loans by $700 million or 1.4% on a linked-quarter basis. Loan growth was concentrated in the commercial bank, where we continue to see opportunities in strategic segments. C&I grew $85 million, with an additional $125 million in sponsor. Commercial real estate was up $150 million. Mortgage warehouse grew $235 million, consistent with seasonal trends, and residential mortgage grew $140 million. The yield on our portfolio increased 26 basis points.
Excluding accretion, the loan yield increased 27 basis points. Floating and periodic loans remained at 60% of total at quarter end. We provide additional detail on deposits on Slide 9. Total deposits of $3.5 billion from prior quarter were 6.2%. Growth was primarily driven by interLINK and time deposits. Time deposit growth was driven by $1.9 billion in broker deposits and $900 million in consumer banking CDs. Roughly half the consumer time deposit growth was from existing clients shifting into higher-yielding products. A quarter was from the balance increase of existing clients, and a quarter of the growth came from new clients. Commercial deposits grew $700 million when excluding the seasonal decline in public funds. We have started to recapture funds that were diversified across financial institutions earlier this year.
We're seeing new opportunities for growth in transactional accounts. Our total deposit costs were up 61 basis points to 172 basis points for a cumulative cycle to date total deposit data of 34%. On Slide 10, we have updated the forward progression of our deposit beta assumptions. We anticipate a total cumulative deposit beta of 40% by the first quarter of 2024, which is up modestly from our prior projection due to client preferences for higher-yielding deposit products. As you can see in the chart on the right, we expect the pace of our deposit cost increase to moderate over the next few quarters. Moving to Slide 11, we highlight our reported to adjusted income statement compared to our adjusted earnings for the prior period.
Net Interest Income was down $11.5 million, or 1.9% linked quarter, primarily reflecting increased funding costs. Adjusted non-interest income was up $2 million, while expenses remained effectively flat. The Net Interest Margin was 3.35%, down 31 basis points from prior quarter, with 12 basis points from temporary actions to increase our liquidity position. The efficiency ratio was 42%. I'll discuss each major line item on subsequent slides. On slide 12, we highlight Net Interest Income, which declined $11.5 million linked quarter, or 1.9%. Net Interest Margin, excluding accretion, decreased 30 basis points from the prior quarter. Our yield on earning assets, excluding accretion, increased 24 basis points over prior quarter, and the total cost of funds was up 58 basis points.
The change in the cost of funds was driven by a mix change in deposits, as well as additional liquidity we added early in the quarter. A significant driver for the linked-quarter decline in NIM was an increase in the average balance sheet liquidity of $2.6 billion. While this did not impact Net Interest Income, it has 12 basis point impact on our NIM relative to prior quarter. Higher funding costs drove the remainder of the decline as deposit competition increased. On Slide 13, we highlight our non-interest income for the quarter. On an adjusted basis, non-interest income was up $2 million linked-quarter. The primary driver was an increased valuation marks on the client hedging activity. Transaction activity tied to commercial clients remained slow in the second quarter, but we're seeing some signs of modest improvement in the coming quarters.
The year-over-year decrease was primarily driven by $12 million in lower client hedging activity, $7 million in lower loan-related fees, $6 million in lower client deposit fees, $4 million due to the outsourcing of our consumer investment services platform. Non-interest expenses is on slide 14. Reported adjusted expense of $303 million, in line with the prior quarter. A reduction in professional fees and technology expense was offset by higher employee benefit expense and deposit insurance. Slide 15 details components of our allowance for credit losses, which was up $15 million over prior quarter. After recording $20 million in net charge-offs, we incurred $35 million in provision expense, with loan growth representing $8 million, and the remainder due to changes in the macroeconomic forecast. You see our allowance coverage to loans increased slightly to 122 basis points. Slide 16 highlights our key asset quality metrics.
On the upper left, nonperforming assets increased $35 million from prior quarter. Nonperforming loans represent 42 basis points of loans. Nonperforming assets remain within the range of the past year and are down $28 million from a year ago. Commercial classified loans as a percent of commercial loans declined to 1.39% from 1.47%, as classified loans declined $25 million on an absolute basis. Net charge-offs in the upper right total $20 million or 16 basis points of average loans on an annualized basis. Notably, we divested $80 million in commercial real estate loans in the quarter, vast majority of which were secured by office properties. These divestitures generated $13 million charge-offs. On Slide 17, we continue to maintain strong capital levels. All capital levels remain in excess of regulatory and internal targets.
Our Common Equity Tier 1 ratio was 10.66%, and our Tangible Common Equity ratio was 7.23%. Tangible book value increased to $29.69 a share. Including the AFS mark on our securities portfolio, Common Equity Tier 1 ratio would be approximately 9.4% as of June 30th. We don't anticipate we'll be subject to explicit changes to the regulatory capital requirements, but are well prepared for any potential changes, as evidenced by our capital ratios, inclusive of AOCI and our strong liquidity position. I'll wrap up my comments on Slide 18 with our full year outlook. We expect to grow loans in the range of 4%-6%, with growth focused in strategic segments. We expect to grow core deposits 8%-10%, the year-end loan-to-deposit ratio in the mid-80s.
We expect net interest income of $2.35 billion-$2.375 billion on a non-FTE basis, excluding accretion. Approximately $25 million in accretion would be added to that interest income outlook. For those modeling net interest income on an FTE basis, I would add roughly $65 million to the outlook. Our net interest income outlook includes the growth expectations above, along with a 25 basis point Fed hike next week. We assume the Fed funds rate will remain flat for the remainder of 2023 at 5.5%. We currently expect NIM to improve by 10-15 basis points from the second quarter level to the remainder of the year. Non-interest income should be in the range of $355 million-$365 million.
Core expenses are expected to be in the $1.2 billion-$1,225 million range, with an efficiency ratio in the 40%-42% range. We expect our effective tax rate in the range of 22%. We'll continue to be prudent managers to capital. Capital actions will be dependent on the market environment. We continue to target Common Equity Tier 1 ratio 10.5%. With that, I'll turn it back over to John for closing remarks.
John Ciulla (CEO)
Thanks a lot, Glenn. I'll wrap up my remarks today with a short update on our integration and strategic path forward. We're approaching an important integration milestone this weekend with the conversion of our core operating systems. As many of you are aware, we took a deliberate and thoughtful approach to the conversion of our core. A tremendous amount of work has gone into this event, as our teams have been working diligently to accomplish the smoothest experience possible for our clients, while at the same time maintaining the level of service they have come to expect. We completed three mock conversions over the first half of 2023 and have been proactively communicating with clients in recent weeks. We've already enabled our entire ATM network to access a consolidated core, and our frontline colleagues have been trained on new systems and procedures.
Several of our back-office systems have already been consolidated, and we're excited to complete this meaningful step from an operational perspective. Post-conversion, we'll be able to accelerate our strategic technology plans and will be in a position to further realize additional synergies. I want to thank all of our colleagues who are focused on the conversion, whether in a dedicated role or through our continued focus on taking care of our clients across our footprint. We'll continue to invest in and grow products and capabilities as we deliver a superior experience to our clients, and we simplify business processes for colleagues and other business partners. As investors and business partners, you'll continue to see the full capability of this company.
Webster's earning power, its strong capital and funding profile, differentiated commercial businesses, colleague talent, and engagement are all attributes that enable Webster to generate peer-leading returns through a variety of operating environments. We'll utilize our strong operating profile and flexible capital position to continue growing share in our key markets and business segments, allocating our resources to the highest return opportunities to maximize economic profit, all within a disciplined risk management framework. I want to thank you all for joining us today. Operator, with that, Glenn and I will be happy to take questions.
Operator (participant)
At this time, I would like to remind everyone, in order to ask a question, please press star, then the number one on your telephone keypad. Your first question comes from Chris McGratty with Keefe, Bruyette & Woods. Your line is open.
Chris McGratty (Managing Director)
Hey, good morning. Thanks for the update, guys. Glenn, on the NII, maybe you could talk through the ranges of NII, the range of outcomes. Is it more about the Fed? Is it more about competition? I guess, what would it take at this point for you to take a different view of NII? Thanks.
Glenn McInnes (CFO)
Yeah, thanks. Chris, I think it is probably primarily driven by increased deposit costs, increased funding costs as a whole. That's why we adjusted that range down a little bit. The second part of your question was?
John Ciulla (CEO)
It's probably a combination.
Chris McGratty (Managing Director)
Yeah.
John Ciulla (CEO)
I'm sorry, Chris. It's a combination of our assumption of feds going with one more rate hike and just general deposit competition. As you see, we see NIM expansion coming off this quarter because of the dynamics in our balance sheet, but also because of, you know, our floating rate loan book and the pace at which we think deposit costs will grow. Plus, we have some good guys coming in the 3rd and 4th quarter with respect to kind of core commercial growth, seasonal growth in lower cost government deposits. That's kind of what factors into where we are with obviously the governor being just overall higher deposit and funding costs industry-wide.
Chris McGratty (Managing Director)
Got it. Thanks. Thanks for that. In terms of just regulation, right, you're comfortably below 100, but obviously, I think the market will expect at some point you'll be there. Can you just talk through the expense angle potentially, that you're thinking about, and also how your capital targets may evolve and capital return strategies may evolve? Thanks.
John Ciulla (CEO)
Yeah, Chris, it's a great question, and obviously we're spending a lot of time thinking about it. I think it's too early to even throw out kind of a wild guess on cost. I think, you know, the reality is, even if you're at $85 billion, you know, the trickle-down effect of the way you're regulated, you certainly need to begin being prepared. I actually think our infrastructure, with respect to stress testing and the way we measure liquidity, we've held ourselves to LCR for a long time, even when we didn't have to, pre-merger. I think we have the infrastructure to deal with whatever regulations come down.
I think more than internal costs, right, I think the impact would be, is exactly as you intimated at the end there, would be higher capital levels, higher liquidity requirements that would have an economic kind of, you know, impact on the bank if we have to hold more liquidity and different types of liquidity and have more capital. It would be too early to give you kind of our expectations. We're just following it closely. As I said, I think internally we have the capabilities, the systems and the people to be able to deal with whatever comes at us as it's phased in over time.
Glenn McInnes (CFO)
The only thing I would add to that, Chris, is you saw in my comments on our Common Equity Tier 1, even if we were to add in the AFS losses, we'd be at, like, a 9.4%, you know, from 10+%, 10.6%. You know, that would probably be phased in over time.
Chris McGratty (Managing Director)
Okay. Is there any contemplation of a share repurchase, given the strength of the balance sheet, or is it too uncertain on the economy?
John Ciulla (CEO)
You know, I think as we go into it, you may have seen, we repurchased $50 million or so of shares to offset, you know, grants to employees and colleagues throughout the organization. We certainly have the capability to do it in the second half. I think, you know, if we stick to our normal view that I think we're good stewards of capital, so we look at internal opportunities to deploy capital first. You know, we contemplate things like balance sheet restructuring. We look at, you know, tuck-in acquisitions for HSA and other things. If that's not there and we continue to generate the kind of capital we are, and it looks like the credit environment remains stable, you know, you'd see us absolutely looking at share repurchases.
I think it's a matter of time and our view of the, of how stable the ultimate credit environment is as we move through the third and fourth quarter.
Chris McGratty (Managing Director)
All right, great. Thanks, John.
John Ciulla (CEO)
Thanks, Chris.
Operator (participant)
Your next question comes from Casey Haire with Jefferies. Your line is open.
Casey Haire (Managing Director)
Thanks. Good morning, guys. Glenn, question on the NIM forecast in the back half of the year. That lift of 10-15 basis points, is that immediate? It feels like it could be, given the borrowing where the borrowings ended the quarter. It feels like it was back half weighted. Just some color there. In the interest the spot deposit costs and interest-bearing deposits.
Glenn McInnes (CFO)
Yes, let me hit that. Yeah, you're right. I mean, 12 basis points come back to us, and that's the function of, you know, the balance sheet liquidity and us bringing down balances held at the Fed, you know, which we're averaging, you know, $3+ billion in the second quarter. You get back 12 there. You get another 12, another 5 on loan impact. You have about 2 basis points in NIM coming from, you know, the variable book, and then another 3 basis points from the fixed book. That's 5, right? The investment portfolio, same sort of thing. You pick up about 3 basis points there. Of course, you know, further deposit repricing.
The thing I pointed out there is it's probably negative, you know, 6–7 basis points. Not as severe as it was first quarter, second quarter, obviously, because we've built up some of the key higher cost products like interLINK and broker CDs. Yeah, you should begin to see that come back in, beginning in the third quarter, you know, significantly. On the second part of your question, I think our exit cost was on deposits, and that's like 184.
Casey Haire (Managing Director)
That's total or is that interest-bearing?
Glenn McInnes (CFO)
That's total. [audio distortion]
Casey Haire (Managing Director)
beta assumption, 40%, what through first quarter 2024? I guess if the Fed is on hold and we're higher for longer, you know, is that beta, can that 40% beta go higher? And then what does the beta forecast assume for DDA mix at 19% on total deposits
Glenn McInnes (CFO)
Yeah. A couple of things in there. Our forecast is that the Fed increases next week and stays at 5.50 for the rest of the year. That ties to that 40% that you're seeing on the slide. I think that's the first part of your question. I think there is a lag. There has been a lag on Fed increases and how that's trickled down to the deposit base, and it's been like a quarter or 2 for the most part, and that's again, why you see some of that acceleration in the second quarter. I think the second part of your question was on DDA deposits as a percent. Was it as a percent of total?
For us, you know, if you, if you look at it, I think, you know, at fourth quarter of 2022, we were a combined organization, 25%, right? One of the things that's happened here is we've grown interLINK and brokerage, and so that's increased the total deposit base. You know, if you look at that, full year basis, you're probably in a range of 18.5%-19% by the fourth quarter. If you were to strip out things like interLINK and brokerage, you're probably close to 20%-21%.
John Ciulla (CEO)
Casey, it's John. I think one of your questions in there was what are your assumptions if what happens to beta if the cycle is longer? You know, I think our view is, could it tick up a little more? I guess, but that most of if they stayed flat and higher for longer, that most of the beta and most of the increase would be captured by Q1. You could have a little drift up over time, but we think that, you know, the behavior is moderate.
Casey Haire (Managing Director)
Yep. Okay, got it. That's fair on DDA mix, too, on the interLINK growth. Last one for me, just on the, on the capital management front. Did you guys buy back any shares? The share count was lower, but I didn't see any mention of it. Then just any updated thoughts on appetite for buyback activity going forward?
John Ciulla (CEO)
Casey, I just mentioned, answering McGratty's question, that we did about $50 million of share repurchases in the quarter to offset grants to employees. Yes, we did. I mentioned that, you know, we'll have the same sort of disciplined approach. We are generating capital, a good amount of capital, obviously, annually, and we're slightly above our CET1 target. To the extent we don't have internal opportunities to deploy capital or a really compelling balance sheet restructuring, you know, we would look, as long as there weren't signs of significant credit deterioration, we would look to deploy some level of capital into share repurchases as we look to the second half of the year.
Casey Haire (Managing Director)
Great. Thank you.
John Ciulla (CEO)
Thank you.
Operator (participant)
Your next question comes from Matthew Breese with Stephens Inc.. Your line is open.
Matthew Breese (Managing Director)
Hey, good morning.
John Ciulla (CEO)
Hey, Matt.
Matthew Breese (Managing Director)
Maybe to start, could you just give us some idea of what incremental loan yields are today? Assuming they're higher, how has that impacted originations and pipeline on a month-to-month basis?
John Ciulla (CEO)
Yeah, it's a complex question. Well, we get the yields. You know, let me start with credit spreads could be an interesting way to start. There's no question that I think us, like most of the industry, are being kind of more demanding and more disciplined in terms of where we're generating loans and how we're generating loans. We have seen increases in credit spreads. If you think of obviously the reference rates and so forth, and prime continue to move up, but we're also seeing a level of expansion. I was talking to the team yesterday in kind of construction-related CRE.
You can get 75 basis points plus with respect to additional credit spread from pre-March on other sort of more traditional and predictable CRE outside of office, which obviously people aren't doing, it's more like 50 basis points. On C&I, the team's seeing kind of 25–50 basis point expansion in credit spreads. Take those credit spreads over, you know, the expanding reference rates, and Glenn can give you the yields.
Glenn McInnes (CFO)
Yeah. Matt, the yields on both the quarter to date and for the month of June were sort of the mid sevens, right? You know, obviously, that's going to be driven by mix and product mix. Generally, when you look at the quarter and you look at the month, it's in the mid sevens.
Matthew Breese (Managing Director)
Great. Thank you. I was curious on the $80 million in office loans that you divested. I'm just curious how that process went. How liquid was the market for office loan buyers? What kind of comfort does that give you on potential loss content on the rest of the office book? Is there any more you're looking to do there?
John Ciulla (CEO)
Yeah, it's a great question again, and there's not a way to give a kind of definitive, quantitative answer. I think we've clearly seen, and as you've seen, I'm really proud of the team. We've reduced office exposure by 25% over the last four quarters with really minimal hit to capital and minimal credit loss. There is no question that the amount of liquidity, and the eagerness of purchasers in the market for loans is it's more expensive now than it was four quarters ago, just given kind of people's view of the market. There still is a lot of liquidity, a lot of private capital, as you know, out there, and so that is encouraging to us in terms of our ability.
If we've picked good pieces of property to finance, at the end of the day, if there's alternative uses for those properties or even if there's been a valuation decline, but there's still clearly equity in the property, we've been able to find buyers. You know, this last quarter, we said that $80 million represented roughly 50%-60% of our charge-offs in the quarter. We think obviously with respect to non-critical and strategic office properties, that's the right move now. It's getting more expensive. I think we'll continue to be proactive. We feel really good about the fact that we've paired the portfolio thoughtfully and, you know, it's now down to below $1.3 billion non-medical office. There are buyers
of this real estate at a reasonable price, still out there, although it's obviously getting more expensive to execute on kind of balance sheet moves like that.
Matthew Breese (Managing Director)
Last one for me. You know, in late June, there was some joint interagency guidance from, you know, the FDIC, the Fed, the OCC, on prudent commercial real estate loan accommodations and workouts. I would like your perspective on how this plays out practically. You know, what does it look like in terms of how you help customers or how you can help customers? You know, what are the expected tools that can be used, and how will these accommodations and workouts be disclosed if and when they occur?
John Ciulla (CEO)
Yeah, another loaded question that I don't know I can answer with specificity, but I'll give you my perspective. You know, during obviously, and, you know, I'm not gonna go back to a history lesson, but in the early 90s, obviously, the regulators, with respect to real estate, really, you know, killed the banking market and accelerated and were very prescriptive with respect to the way they looked at restructuring. During the great financial crisis, you know, when I was chief credit risk officer here, I thought they were very constructive in terms of making sure that as long as you were realistic with respect to the return you were getting on the loans, that they knew it was in everyone's best interest to modify. We're seeing that general tone and tenor, I think, from the regulators, again, which will be constructive.
My view is, and our view, at least internally in the bank, is you don't wanna artificially kick the can forward if there's not a reasonable credit to be renewed. I think the regulators are still gonna hold us accountable to making sure that we're taking appropriate losses, we're recognizing nonaccrual loans, and that we're not, you know, able to modify things artificially that really aren't good loans. You know, so far, we're able to work with our sponsors and real estate owners and either get a little bit of additional proceeds, and in consideration, we underwrite at a slightly higher LTV if the cap rates have changed the value.
So far, Matt, you know, we've seen a kind of a constructive stance, and I think from our vantage point, that's really helpful, but it also doesn't give us the opportunity to sort of, you know, artificially kick forward a loan that really shouldn't be kicked forward. I think that's the way the analysts and the investors will see it, in that if you don't have enough cash flow to service your loan, you know, you're gonna have to take appropriate action and classify and risk rate the loan appropriately. If you've got cash flowing loans, but it's just gonna take longer to repay or you've got a higher LTV, I think we're gonna have some flexibility in being able to work with the borrowers to a good outcome.
Matthew Breese (Managing Director)
Great. I appreciate it. I'll leave it there. Thanks for taking my questions.
John Ciulla (CEO)
Thank you.
Operator (participant)
Your next question comes from Brody Preston with UBS. Your line is open.
Brody Preston (Executive Director)
Hey, good morning, everyone. How are you?
John Ciulla (CEO)
Morning. Good morning.
Brody Preston (Executive Director)
I did wanna follow up maybe just on the office line of questioning. We saw another bank, you know, that just reported that sold their medical office portfolio, and it was only, like, a 2.5% mark. I think maybe it was a bit, you know, non-core for them, but I guess could you maybe speak to, you know, the puts and takes between maybe keeping even medical office around? Is that a core kind of product for you?
Do you have deposits tied to those borrowers, or is that something where, you know, as you just evaluate your overall office exposure, even if it's something like medical office, you might look to kind of exit it, you know, are you now as opposed to waiting later down the road?
John Ciulla (CEO)
Yeah. Specifically to medical office, I don't think so. It's such a different animal. you know, right now, it's still really strong. Vacancies are low, rates have held, our portfolio is not particularly big, and right now it's a profitable business. Oftentimes, and most of the time, we have ancillary revenue, either coming from deposit liquidity or fees or other cash management products. I, I don't think that's in our strategic wheelhouse right now, and I don't think we feel from a credit perspective, it's something we need to do.
Brody Preston (Executive Director)
Got it. Okay. Thank you for that. I did wanna just ask on the available-for-sale portfolio, and I'm sorry if I missed it in the, in the deck, but do you happen to have what the effective duration of that portfolio is? Could you tell me what the assumed conditional prepayment rate you're using in the duration calc is?
Glenn McInnes (CFO)
Sure. The duration is 3.8 years, and the CPR we're using is in the high single digits.
Brody Preston (Executive Director)
Got it. Okay. Then I just wanna ask just, you know, the credit seems to be holding up really well, but it seems like, you know, last quarter across the industry, there was a couple one-offs. This quarter across the industry, there's a couple more one-offs. There's some kind of indication that maybe, you know, especially in middle market, you know, maybe you're starting to see some pressure on borrower balance sheets. You know, how are your conversations with borrowers, particularly in middle market, evolving today, and, or, you know, how are they handling higher interest rates, and what are some of the key areas of pressure that they're identifying?
John Ciulla (CEO)
Yeah, and again, I'll try and be brief, but give you some insights. You know, I think you're right. I think everybody is surprised that credit's held on so strongly. You know, you look at our metrics, we're not seeing correlated risk across portfolios. We're being proactive in obviously in office, just given the secular dynamics there. You know, I think from a risk rating perspective, if you look across the industry, you know, there was kind of stable. I think probably now the bias is to downside. You know, although, as you said, it's really only resulted in kind of one-offs from a loss perspective. I think most folks in the industry expect there to be a little more bumpy as we go forward in the next several quarters.
It probably is, to your point, the cumulative impact of debt service, higher interest rates, higher input costs, inflationary pressures on wage and other input costs into businesses. You know, we hear, it's funny, what we hear mostly from our clients is the same thing. It's about they feel good about demand, they feel good about their customers' confidence. They're still having trouble finding people to either work in their plants or to work on their counter of their service company. No doubt that higher costs, input costs, and higher interest rates put more pressure on them. We're not seeing much capitulation, Brody.
As I said, if you look across all of our different sectors and our geographies, which we do all the time, to look for any sort of correlated performance behaviors or risk, we're not really seeing anything right now. You know, our charge-offs this quarter at 16 basis points are actually 3 basis points below our five-year average charge-off rate, pre-pandemic. 60% of those were on proactive office sales. You know, it certainly hasn't shown yet through a lot of the statistics.
Brody Preston (Executive Director)
Got it. Okay, thank you for that. Then one last one for me, and again, I apologize if I missed it. I was hopping from another call. Just on the fee income, I know it's not a huge driver of revenue at this point, but, I guess, you know, Glenn, what would cause you to kind of be at the high end or the low end of the guidance? I think the last time we talked, we had spoken maybe about, you know, commercial swap activity picking up a little bit in the back half of the year. Do you still feel like that's a possibility?
Glenn McInnes (CFO)
Yeah, I mean, we do see some modest increase in activity or forecasting some modest increase in the second back half of the year. That's all within our guide range as well.
Brody Preston (Executive Director)
Okay, great. Thank you very much for taking my questions, everyone. I appreciate it.
John Ciulla (CEO)
Thank you.
Operator (participant)
Your next question comes from Mark Fitzgibbon with Piper Sandler. Your line is open.
Mark Fitzgibbon (Managing Director)
Hey, guys. Good morning.
John Ciulla (CEO)
Hey, Mark.
Mark Fitzgibbon (Managing Director)
John, I heard your comments on credit, and I know this is relatively small dollars, but you had a, about a $23 million uptick in commercial non-mortgage, non-accruals this quarter, and it looked like 30 to 89 day delinquencies in that bucket also went up. Is there anything, you know, unique or to that bucket or any particular industry that's being challenged?
John Ciulla (CEO)
The delinquencies are mostly administrative. I would say that the two, one was a non-office CRE and one was a C&I loan. We had a couple of credits that led to that. They were really kind of one-off. I was talking with Jason Soto, our Chief Credit Risk Officer, you know, who said, you try and look for dynamics there, and it really was more idiosyncratic management missteps. You know, it happens, inflows and outflows, and we work at it proactively. I, again, you know, I haven't seen anything there that leads that there's a parade of issues behind either of those credits.
Mark Fitzgibbon (Managing Director)
Okay. Given what you see today, you know, on credit and for loan growth, how should we be thinking about provisioning levels for the back half of the year?
John Ciulla (CEO)
I mean, Glenn can talk from a technical CECL perspective. You know, I think we're pretty conservative. We've got a good, you know, we're a top decile among our peer group, coverage ratio right now, CECL coverage. You know, we're thoughtful about the uncertainties in the macro market. A lot of it's driven by the inputs of risk rating dynamics. The more you proactively deal with troubled credits, obviously, that helps you in terms of what you have to, what you have to post going forward.
You know, my personal view is I'd like to keep a robust coverage ratio, but it's all going to be dependent upon how credit performs, what the risk migration is like, and how proactive we are on being able to resolve, remedy, get payoffs, or sell, you know, criticized and classified assets, Mark. I would say kind of it's state of course, look at it, look at what we've been doing, think about movements in the portfolio, and it's probably similar levels to what you've seen in the last few quarters.
Mark Fitzgibbon (Managing Director)
Okay. Lastly, should we expect merger charges from Sterling to wrap up in the third quarter, you know, post-systems conversion? Will they be done and behind at that point?
Glenn McInnes (CFO)
Yeah. Mark, you expect it to wrap up in the fourth quarter, but you've seen it trending down, yes.
Mark Fitzgibbon (Managing Director)
Thank you.
John Ciulla (CEO)
Thank you, Mark.
Operator (participant)
Your next question comes from Manan Gosalia with Morgan Stanley. Your line is open.
Manan Gosalia (Executive Director)
Hey, good morning.
John Ciulla (CEO)
Morning.
Manan Gosalia (Executive Director)
I get this question a lot, and I wanted to see how you answer it. What do you make of the argument that if rates stay higher for even longer, the difference in peak deposit betas between banks should narrow, and banks that have lower betas, like yourselves, will see a larger increase in deposit rates than some of your peers that already have higher betas?
Glenn McInnes (CFO)
I think it all depends on by bank, it depends on the composition. For us, as you know, we have HSA, which basically has a through the cycle beta of 2%.
you know, that's a differentiator for us. If you looked at our other lines of businesses, you know, between the commercial and the consumer business, those both have different betas as well. I think a lot of that, you know, our commercial beta is, I think, 34%. Our consumer base beta is 22%. I think a lot of that will be driven by the mix shift and the funding profile from each institution.
John Ciulla (CEO)
Yeah, Manan, my view would be similar. It's kind of an interesting question you ask, because you could think about that as kind of everybody kind of reversion to the mean. I do think, as Glenn said, it really ultimately is about your deposit mix and your ability. You know, you saw us drive growth in higher cost deposits in the quarter for a number of strategic reasons. You know, we have expected growth in the second half of the year in, you know, our core commercial franchise, in our consumer book, in our business banking book, in our government operating deposit book. You know, those will be things that should help us mitigate some of the impact of overall higher deposit costs around.
I think, you can't make the assumption that everybody ends up in the same place if we're in this, situation for a long period of time.
Manan Gosalia (Executive Director)
Very helpful. Did you say 2%, through the cycle deposit beta on HSA deposits?
Glenn McInnes (CFO)
Yeah, I did. If you looked at our, you know, I think for the quarter, we said the cycle to date data was 34% on our deposits. If you peel that back, you know, in HSA, cycle to date's been 2%, consumer's been 22%, commercial's been 34%. The difference being the higher beta products that we added in the second quarter are interLINK broker CDs. That's how you ladder up to that number. There's differences within the portfolios, and there's differences within the product sets.
Manan Gosalia (Executive Director)
Is there any environment in which competitive factors push up the beta on those HSA deposits?
Glenn McInnes (CFO)
You know, it's interesting because the customers that are really searching for yield in that product become investors, and they move their balances into investment options. When you think about that, when you think about our 3 million HSA accounts, 75% of those are spenders. They have relatively small balances of, like, $450 in account. It's not as meaningful for them. The, the savers have a larger balance of, like, $6,000-$7,000. As soon as they get a little more scale, they become investors. Investors have a lower demand, lower DDA savings balance and a higher investment balance.
Those that are in that savings category and decide to move to investors, still, generally, if you look at their balances at $45-$5,000, are multiples of what the spenders are. Like I said, 75% of our customers are spenders today.
Manan Gosalia (Executive Director)
That's very helpful. Thank you.
John Ciulla (CEO)
Thank you, Manan.
Operator (participant)
Your next question comes from Steven Alexopoulos with JPMorgan. Your line is open.
Steven Alexopoulos (Equity Analyst)
Hey, good morning, everyone.
John Ciulla (CEO)
Hey, Steve.
Steven Alexopoulos (Equity Analyst)
I wanted to start. First, to follow up on the comments around the positive trajectory for NII for the rest of this year, what are you guys assuming in terms of additional non-interest-bearing outflows in that assumption?
Glenn McInnes (CFO)
I think on an absolute basis, you know, we're in the quarter on non-interest bearing, 11.3, 11.4. That'll as a flow, I mean, like John said, we have some municipal funds that have come in, some additional transactional funds that come in. I think we'll probably end the year within that range, given the puts and takes, too.
Steven Alexopoulos (Equity Analyst)
Got it. Okay, pretty flat from here. Okay.
Glenn McInnes (CFO)
Yep.
Steven Alexopoulos (Equity Analyst)
I'm curious, on the deposit competition side, seems like most banks were building liquidity this quarter, and it's really played out, right? We're not seeing that as much for Q3. When you look at the competitive environment, is it easing a bit here in the third quarter?
John Ciulla (CEO)
Yeah, I, you know, I don't think the competition is easing. It may be because the Fed has paused, and it's been such a big, you know, increase that people who are rate sensitive, given and the banks, you know, wanting additional liquidity, that it was a perfect storm in Q2. I do think that the pressure on deposit prices, pricing eases, but I'm not sure, Steve, I wouldn't characterize it as the competition for deposits easing. I think that's kind of why you're seeing most of the folks in the industry take a position that the increase in deposit costs kind of moderate but continue.
Obviously, we all think that deposits are the most valuable thing, and obviously, we're relying, want to rely more on our relationships than just going out and chasing deposits for rate. I think competition stays strong, but I think the pressure on pricing moderates.
Steven Alexopoulos (Equity Analyst)
Got it. Okay. Finally, on the regulatory front. Your period and assets are almost $75 billion, right? We're all waiting for the new regulations for banks above $100 billion to hit. I know we need to wait for the details, but John, what's your messaging internally at this point to the team? Are you looking at this saying, "Okay, we're close enough. Whatever comes out, we're going to work to comply with it." Now, do you feel like you have time to comply with what comes out? Like, how are you viewing it at this stage? Thanks.
John Ciulla (CEO)
Yeah, it's great. That's a good question. I'll reiterate a bit of what I said before and maybe add to it. I'm really happy with our risk infrastructure. Our regulatory relationships right now are remaining strong. It's always been a real focus of mine and of the team. As I mentioned earlier in response to another question, we've already complied with LCR. We obviously, we stress test internally, even though we don't have obligations to disclose externally. We feel with this merger that took us over $50 billion, we are on the path to heightened standards already. We've built the infrastructure, I think, to continue to comply and to continue to execute in whatever the regulatory framework is. When people ask, you know, how much additional cost will it be?
On and so forth, I think I feel really good about where we are from a people, a process, and a system perspective. The real hit is going to be, if there is one, what are the actual capital and liquidity requirements as we move forward? I think your point is a good one. As we move from $75 billion–$80 billion to $85 billion, we're clearly going to have to comply and be ready for whatever is out there. We will likely, when these new regulations are implemented, have an opportunity and a time to adopt. You know, we won't, we won't rush. We'll make sure we're compliant, but we'll get ourselves fully prepared. The way I look at it is, I don't feel like we're going to be blindsided, and it's going to slow us down significantly.
There'll be if there are additional capital and liquidity requirements, those will be what they'll be, but on a relative basis, they'll be for all of our peers and our competition. I feel good that we'll have time to make sure that we implement whatever's there. The message to the team, as you said, is, you know, keep doing what you're doing. Make sure that we're meeting all the heightened standards as a above 50 billion dollar bank, obviously get ready for whatever's going forward with respect to our internal systems, our risk management processes, make sure we have the right people, I feel really good about that.
Steven Alexopoulos (Equity Analyst)
Okay. Thanks for all the color.
John Ciulla (CEO)
Thank you, Steve.
Operator (participant)
Your next question comes from Daniel Tamayo with Raymond James. Your line is open.
Daniel Tamayo (Director)
Hey, good morning, guys.
John Ciulla (CEO)
Yes.
Daniel Tamayo (Director)
Most of my questions have been asked and answered at this point. Just have one more follow-up on the fee income side, and I apologize if I missed this. My call cut out for a second there. Just curious, you know, what your expectations are, and obviously, the guidance came down, but, you know, in terms of a rebound long term, I mean, what does it take to get back to where you were? Then, you know, how does that impact the expense side as well?
John Ciulla (CEO)
Yeah, let me give you at the high level, Dan, and then Glenn can fill in any of the charts. You know, we're a strong commercial bank with strong relationships, and we cross-sell lots of products, and so we really grew our non-interest income on the backs of our commercial banking relationships. What you saw driving higher levels of non-interest income last year were things like swap fees, syndication fees, loan fees, equity kicker, investment realizations from our sponsor and specialty group. A lot of that, given the market dynamics, has kind of stopped. Obviously, with the higher interest rates, where none of the industry is selling as much, you know, swap business.
With respect to our business in particularly commercial real estate and sponsor and specialty, where we have more capital market fees, when the kind of ride stopped for a bit in March, we've seen a slowdown. I'm telling you that because I think those would be the dynamics that when we reach a more normalized environment, which I think we expect to be in the fourth quarter or first quarter of next year, but we've been a bit conservative in our forecast that you've seen in our guidance. We start to drive a lot of those ancillary, you know, treasury management fees, FX fees, swap fees, capital markets fees, e-equity kicker investment realization. That would be a driver immediately.
As a management team, you can imagine, we're also focused on making sure that we, over time, can have a higher percentage of our revenue, in fee-generating businesses as well. That's a strategic emphasis for us.
Daniel Tamayo (Director)
Terrific. That's all I had. Thanks for the color.
John Ciulla (CEO)
Thank you.
Operator (participant)
Your next question comes from Bernard von Gizycki with Deutsche Bank. Your line is open.
Bernard von Gizycki (Equity Research Analyst)
Hi, good morning.
John Ciulla (CEO)
Good morning.
Bernard von Gizycki (Equity Research Analyst)
My next question. You discussed about $120 million in cost savings post the Sterling conversion, which is expected by this weekend, as noted. You know, you also mentioned that several back office systems have already been consolidated, and I think the acceleration of your tech plans will lead to further synergies. Can you just remind us, do some of these cost savings come through this year, or is it an entire amount for full year 2024? Is the $120 million still the cost savings estimate?
John Ciulla (CEO)
Yeah, no, it's a great question. Let me give you a little perspective. When we announced the transaction, we announced about a 10% synergy in cost saves off of our combined run rate. That was a combination of FTE reduction, about halving our office and corporate real estate space, getting rid of duplicative vendor contracts, and then obviously, as you mentioned, completion of the conversion, back office efficiency, synergies, combination of the call centers, some branch consolidation, all of that sort of post-conversion. Obviously, the conversion being pushed out 15 to 18 months from close, stopped some of the realization of that. In the interim, we've also talked about the fact that when we made our announcement on cost synergies, we didn't have a 6%, 7% wage inflation rate.
We didn't contemplate at the announcement, the acquisition of Bend and HSA, the acquisition of interLINK, about $25 million higher in FDIC costs and other general inflationary pressures. I think the way to look at it is we do have opportunities that probably will be realized in 2024 because we're doing the conversion now, and then we're consolidating call centers, and we're looking at back-office synergies once we've retired some of the subledgers. The remaining cost savings that we're talking about there probably won't impact 2023 materially. The reality is, you saw us keep our core non-interest expense flat period-over-period, which is sort of bucking the trend in the industry.
The general synergies of putting these two banks together have enabled us to keep our efficiency ratio, you know, in the low 40%, during a period of time, obviously, when expenses are getting higher and higher. The way we look at it is we benefited from realizing a good amount of the $120 million target, about 75%. Some of that has been offset by additional investments and acquisitions. We do have opportunities in the back half of 2023 to get more efficient, which will benefit our run rate in 2024. As we've said all along, this is really a growth story, and we're going to continue to invest in our differentiated businesses.
If you look at what Jack and I said, geez, almost 3 years ago when we announced the transaction, that 2 years into the transaction, we would be posting a high-teens ROATC, an ROA above 1.4, and an efficiency ratio in the 40%-45% range. We posted that at year-end 2022. We posted that this morning, and we expect to post that again on 12/31 for the full year. We feel like we're delivering, you know, the financial results, and certainly, being one of the most efficient banks, you know, in our peer group, if not the most efficient, is helping us do that.
Bernard von Gizycki (Equity Research Analyst)
Oh, great. Thanks for that color. Maybe just, as, one question on deposits. You know, the interLINK balances reached $4.3 billion, which is over two quarters. I believe that's versus your target of about $5 billion.
John Ciulla (CEO)
Yep.
Bernard von Gizycki (Equity Research Analyst)
I'm just kind of curious, is that still your target? Can you pull further into that? I think on the call earlier, you mentioned seeing some new opportunities for growth in transactional accounts. Maybe you could just give a little color on where you see the deposits, like, you know, where growth will come maybe in the second half of the year.
John Ciulla (CEO)
Yeah, it's a good question. interLINK was on end of period, interLINK was just under $2.9 billion in the first quarter. Obviously, we're at $4.2 billion. I think, you know, the growth in that will moderate over the next couple of quarters. you know, I'm totally probably in a range of $100, $200, $150 million, somewhere around there, but certainly not the increase that you saw in the second quarter. You'll see growth sort of moderate from that point on. you know, we had a target of $5 billion-$6 billion, so I think it by quarter, you know, by the fourth quarter, you know, we'll probably be, you know, at or slightly under that target.
Bernard von Gizycki (Equity Research Analyst)
Okay, great. Thank you for taking my questions.
John Ciulla (CEO)
Thanks, Bernard.
Operator (participant)
Your next question comes from Jared Shaw with Wells Fargo Securities. Your line is open.
Jared Shaw (Managing Director)
Hey, everybody. Good morning. Thanks for answering-
John Ciulla (CEO)
Hey, Jared.
Jared Shaw (Managing Director)
I think most of what I was looking for was answered, but, you know, as you look at the loan yields, you talked about better spreads. Do you think that that can still move higher as we go through the year, if the Fed moves as expected?
John Ciulla (CEO)
Yeah, you know, we do. Obviously, we'll get if we get another rate increase, the reference rates will slide up a bit. From a credit spread perspective, I think my base case would be that we do. You know, the dynamics are interesting. People are choosing to play in different sectors and different asset classes. And, you know, loan demand is sort of unpredictable. It's slower in a bunch of areas, and there's some decent demand that we expect in the back half of the year. I think us and the rest of the industry will continue to be thoughtful about deploying capital and making sure that we're getting paid for risk.
I expect that credit spreads and structure from a bank's perspective, from the lender's perspective, will continue to modestly improve as we go into the second half, Jared.
Glenn McInnes (CFO)
Yeah, the only thing I would add to that, Jared, is, you know, 60% of our book is floating or periodic. I think at the quarter, we ended at, like, a 6.06% yield on the book. As you look out, again, we're assuming 25 basis points of the Fed next week. So you're probably adding a couple basis points in the third quarter, a couple in the fourth quarter on the loan yield for the total book.
Jared Shaw (Managing Director)
Great. Thank you.
Glenn McInnes (CFO)
Thanks.
John Ciulla (CEO)
Thanks, Jared.
Operator (participant)
There are no further questions at this time. I will now turn the call back to John Ciulla.
John Ciulla (CEO)
Thank you very much for joining us today. We appreciate your continued coverage and interest in the company. Thank you.
Operator (participant)
This concludes today's conference call. You may now disconnect.
