WBS - Webster Financial

[Guest Schwab711]

This idea revolves around HSA Bank, which is the largest custodian and servicer of HSA accounts in the country. This is a growing source of deposits, due to tax incentives, and is extremely sticky (and low-cost!). Scale in the industry has helped them further grow market share and widened the gap between them and other HSA servicers.

 

Webster Bank is an average regional bank with 163 branches in the CT and MA region. They seem to be of average on a conservative spectrum and have a history of getting out in front of loses with slightly above-average ALLL balances. Haven't looked into their loan book disclosure yet but probably nothing special. Their banking ops are near break-even to slightly negative, with profitability coming from non-interest or fee income. Not surprising but not great.

 

HSA Bank looks to be the driver of future growth. It's already very profitable for a bank of its size, with $40m in net income from $65m in HSA-related fee income. Both net income and fee income at HSA Bank increased >100% in 2015. However, the real interesting fact is the bank's ROA, which has been (approx) 44%, 68%, and 89% in 2015, 2014, and 2013, respectively. HSA Bank only controls 15% of HSA market share in the US and the program itself is still under-utilized. HSA Bank seems poised to grow its share of the pie as the pie itself expands. This is similar to the FICO story a few years ago where an outstanding company with excellent tailwinds is burried inside an average business.

 

WBS appears to be fairly valued at ~1.45x P/B and 16.5x P/E. However, I think WBS's incremental ROA is extremely high for a bank and earnings growth could approach 10%. I think WBS could provide stable returns of > 10% over a 5-10 year period.

 

Finally, WBS seems like an acquisition target and I think they match up well with USB. If they aren't acquired, I think we'll see a lot of bolt-on acquisitions in the HSA space or high-deposit branches in the area.

[benhacker]

Thanks Schwab, I wasn't aware HSA Bank was part of a public co.

 

Interesting.

[Rasputin]

Wow 30+% growth y/y on deposit service fees is miraculous to me. 

 

On the negative side, 25.5% of loans is in commercial real estate.  So far charge-offs still look great, but not sure going forward.  Boston, DC are strong regions but maybe bubbly?  Critized portion of the commercial loans is getting to 7% of portfolio.  Not too far above WFC (with their huge non investment grade oil&gas exposure) but much higher vs BAC or JPM. 

 

Since I've only followed BAC, WFC, JPM, i've never seen such high concentration in commercial real estate.  I've never seen such growth in deposit service fees either. 

[Guest Schwab711]

Let's start with the downside. The loan portfolio is levered in two ways that will make asset deterioration difficult to detect ahead of time. 1) Commercial loans and CRE are generally more volatile and losses (write-offs) can occur quickly. 2) Most of their loans (85%+) are variable interest loans (I would guess ~90% of non-residential loans).

 

From what I understand so far, WBS is extremely competitive underwriting variable interest loans (as in, they attract high quality borrowers) because their cost and duration of deposits (and consequently, eff ratio) allows them to absorb the risk easier than standard banks. At such low rates, most banks cannot take the NIM contraction risk of these loans. It really depends on how aggressive they are internally with their CRE values (and thus, what their LTV sensitivity would be). I'm trying to talk to some folks that work at the bank to learn more about their lending practices but so far no luck.

 

Why I bought a stake:

1) HSA Bank could potentially be sold for the entire market cap alone. A spin-off would take some planning since the bank is carefully constructed to take advantage of these deposits. Two competitors I found are HQY and WAGE. They are trading at 89x and 98x TTM P/E.

• If HSA Bank traded at 65x P/E, you would get a $20b bank for free.
  
• If we apply a more reasonable 40x TTM multiple (=> $2b valuation; 33.3x FY17), you get a $20b bank with ~$160m NI for $1.4b (8.8x TTM P/E).
  
• The average regional bank trades at ~13x. ROTCE has been ~11%-12%. I think overall ROE will ultimately converge to 10%, given constant operating environment.

2) WBS's ROA is heavily tied to the prime rate. Each 0.25% rate hike should provide somewhere between $10m-$25m of net additional after-tax income (I know it's a large range but I'm still working through model). This corresponds to 5%-12.5% earnings growth. With HSA Bank growth, I think it's reasonable to project 5%+ earnings growth over the next 3-5 years (probably will be lumpy due to HSA infrastructure investments, Boston investments, and any variations in ALLL).

 

 

I think the US government is heavily incentivizing folks to use a HDHP + HSA account for health insurance. Regardless of if Obamacare survives, this seems to be the direction the industry is going. The rejection of the Cigna/Anthem merger definitely supports this thesis (more competition in HDHP). It would be great if more knowledgeable folks could chime in on the general health insurance outlook. From my research, HSA Bank is the cheapest full-service option for employers. I think this bodes well for HSA Bank growth assumptions. HSA Bank is currently the market share leader (HQY is a close #2) with ~15% of total HSA deposits.

 

It sure seems like a rate hike will come in the next 12 months. Can't count on this but it would be a nice boost for WBS. I think they would receive the greatest benefit from higher rates of any bank I've looked at. This obviously goes both ways. Any future rate cuts will negatively effect after-tax income.

 

I don't know exactly how this all plays out, but if absolutely nothing changes then WBS should earn a high-single-digit return over an extended period. If any of the potential catalysts occur (multiple expansion, spin-off/IPO, rate hike(s), improved eff ratio, ect) then WBS should easily provide 10%+ returns.

 

http://www.devenir.com/devenirWP/wp-content/uploads/2015-Year-End-Devenir-HSA-Market-Research-Report-Executive-Summary.pdf

[Spekulatius]

What is HSA moat? Nothing I see prevents large competitors to go in and squeeze the profit margins in this business. BOfA, Wells Fargo or online competitors like Ally could easily do that, I think. Other than some scale, I don't see where HSA's edge is.

 

That is the difference to Fico. Fico has a moat due to their IP, HSA's moat is very narrow.

[vox]

1) HSA Bank could potentially be sold for the entire market cap alone.

 

I don't understand how you came to this conclusion. The current market cap is ~$3.4 billion.

 

The HSA Bank has ~$4 billion in deposits and ~$1 billion in investments. It acquired $1.3 billion in deposits and $175 million in investments from JPMorgan in 2015 for $50.5 million.

 

From the 2014 10-K:

 

"NOTE 24: Subsequent Event

On January 13, 2015, the Company, having previously received regulatory approval, completed its acquisition of the health savings account business of JPMorgan Chase Bank, N.A., for a cash purchase price of $50.5 million. Webster received approximately $1.4 billion in deposit liabilities and a corresponding amount of cash. The estimated fair values of identifiable intangible assets acquired, as well as any goodwill to be recognized, are presently being evaluated and are yet to be determined."

[oddballstocks]

1) HSA Bank could potentially be sold for the entire market cap alone.

 

I don't understand how you came to this conclusion. The current market cap is ~$3.4 billion.

 

The HSA Bank has ~$4 billion in deposits and ~$1 billion in investments. It acquired $1.3 billion in deposits and $175 million in investments from JPMorgan in 2015 for $50.5 million.

 

From the 2014 10-K:

 

"NOTE 24: Subsequent Event

On January 13, 2015, the Company, having previously received regulatory approval, completed its acquisition of the health savings account business of JPMorgan Chase Bank, N.A., for a cash purchase price of $50.5 million. Webster received approximately $1.4 billion in deposit liabilities and a corresponding amount of cash. The estimated fair values of identifiable intangible assets acquired, as well as any goodwill to be recognized, are presently being evaluated and are yet to be determined."

 

They paid 3.8% for the JPM deposits, on that basis their HSA deposits are worth $155m.

 

Why would HSA bank be worth 40-65 TTM earnings?  Banks are trading for about 13-17x earnings.  I understand that HSA's are a growing business, but to me there is no reason for them to trade for that high of a multiple of earnings.  There was incredible HDHP + HSA growth due to Obamacare, but it isn't continuing, it was a one-time type deal.

 

The other thing is HSA funds earn a lot less than loans.  I have an HSA, the fees are low.  I don't invest in any funds and essentially pay $0 to the bank to hold my money.  Is the bank lending the money?  I don't know, probably, and if so then it's a good source of funds.  But HSA funds are a lot more liquid compared to deposit accounts.  There are few people funding HSA's to the max with no expected withdrawals.  Most consumers fund their HSA and spend them down each year.  This means a bank can't count on these deposits for longer term lending.  Instead they look at the liquidity needs and view them as short term and invest them in short term investments, which right now aren't earning much.

[vox]

In their 2015 10-K, HealthEquity (HQY) reported that it acquired The Bancorp Inc. and M&T Bank Corp.'s health savings account portfolios for $34.2 million and $6.2 million, respectively. The Bancorp and M&T HSA portfolios consisted of $390 million and $63 million of AUM with 160,000 members and 35,000 members, respectively. The price/ AUM are 8.8% and 9.9%.

 

I'd think the overall value of Webster's HSA portfolio exceeds $155 million, but it certainly doesn't come close to their market cap.

[Guest Schwab711]

@spekulatius:

Ya, the "moat" is purely based on scale, experience, and reputation. I agree it's thin, if it exists, and I didn't mean to use the word moat if I did. It's just a nice business that's both growing quickly and has operational leverage. If it's not sold, I think WBS has a funding advantage over most regional/large banks (mega-banks will always have better deal flow).

 

Nothing will ever be as good as the FICO scores unit. That was an incredible deal. I only brought up FICO for the hidden operating asset that would have a much higher multiple if it was a stand-alone business.

 

@vox:

I'm guessing the JPM unit was unprofitable due to deposits/account. Most banks with HSA custodian/admin programs rely on individuals signing up. I'd guess the CAC would be higher for individuals. HSA Bank gets the majority of their accounts through insurance relationships or agents, which could explain part of the difference. JPM might have also faced a necessary technology investment that they were not willing to make.

 

HSA Bank is earning $50m NI (on run-rate basis; it's a very stable business). That's where the valuation came from.

 

@Oddball

I believe HSA deposits are treated as transactional deposits with the usual associated reserve requirements. They seem like an excellent source of funding if the HSA program is profitable. Otherwise they can become very expensive. I think we see consolidation due to the operational leverage (like any trust custodian business). The high multiple is almost certainly due to projected HSA industry growth and decreased competition from consolidation. HSA accounts make a lot of sense for most folks given the tax benefits of them. I'm not sure Obamacare was much of a driver of deposit growth so much as HDHPs are the best-value for most folks.

 

-------

 

2015 cost of deposits for WFC was 0.26%

2015 cost of deposits for WBS was 0.26%

 

http://phx.corporate-ir.net/phoenix.zhtml?c=73114&p=irol-presentations

 

http://www.courant.com/business/hc-webster-bank-hsa-bank-spinoff-push-20150302-story.html

http://www.kerrisdalecap.com/wp-content/uploads/2015/03/Webster-Financial-WBS-Report.pdf

[vox]

I looked through the Kerrisdale report, here are some of my thoughts:

 

1. The fair value they come up with is $46.26 per share (as of March 2015). The current stock price is $37.48. That implies a ~25% upside.

 

2. The DCF valuation that Kerrisdale comes up with is $1.5 billion for the HSA bank. This seems aggressive. The terminal value is 2.5x tangible book value. There are only 20, in an universe of 1,000 publicly traded banks and thrifts that trade at a P/TBV over 250%. Maybe the market will be different in 2024, but that's certainly not a conservative assumption in 2016. The terminal value accounts for 107% of the total present value. It actually should be higher since Webster carries an equity to assets ratio of 10%.

 

3. It's really hard to organically grow deposits at 20% per year by the time you're at $10 billion in deposits. If you screen for all FDIC insured institutions that have grown at over 15% per year in 2012 - 2015, there are only four institutions that have achieved that starting with assets over $2.5 billion: Synchrony Bank, Signature Bank, Morgan Stanley Private Bank, and Sallie Mae Bank.

 

4. I think the market views the HSA bank more or less appropriately at $600mm - $800mm - which makes sense given the P/E multiples oddballstocks cited on $50mm in net income. That would be roughly 20% of Webster's market cap, which again makes sense given HSA bank's size as a portion of the rest of Webster.

[Guest Schwab711]

I looked through the Kerrisdale report, here are some of my thoughts:

 

1. The fair value they come up with is $46.26 per share (as of March 2015). The current stock price is $37.48. That implies a ~25% upside.

 

2. The DCF valuation that Kerrisdale comes up with is $1.5 billion for the HSA bank. This seems aggressive. The terminal value is 2.5x tangible book value. There are only 20, in an universe of 1,000 publicly traded banks and thrifts that trade at a P/TBV over 250%. Maybe the market will be different in 2024, but that's certainly not a conservative assumption in 2016. The terminal value accounts for 107% of the total present value. It actually should be higher since Webster carries an equity to assets ratio of 10%.

 

3. It's really hard to organically grow deposits at 20% per year by the time you're at $10 billion in deposits. If you screen for all FDIC insured institutions that have grown at over 15% per year in 2012 - 2015, there are only four institutions that have achieved that starting with assets over $2.5 billion: Synchrony Bank, Signature Bank, Morgan Stanley Private Bank, and Sallie Mae Bank.

 

4. I think the market views the HSA bank more or less appropriately at $600mm - $800mm - which makes sense given the P/E multiples oddballstocks cited on $50mm in net income. That would be roughly 20% of Webster's market cap, which again makes sense given HSA bank's size as a portion of the rest of Webster.

 

2/4. Why is there such a large discrepancy between your multiple for HSA Bank and the market's multiple of HQY? How did you arrive at 12x-14x multiple as FV? That would be less than WBS's multiple. Would you really not buy HSA Bank stock if it were trading at 15x-20x earnings? I definitely would, which is probably the easiest way to sum up the thesis.

 

The wide discrepancy in acquisition multiples between large/small companies in the same industry is the entire theory behind platforms/roll-ups (or brands in consumer goods). I think HSA is a fantastic candidate for a roll-up. I could see why others would be skeptical.

 

In general, predicting that the HSA industry will be larger in the future is about as sure of a thing as you can find when it comes to the forecasting. Both the government and insurers support it and individuals are heavily incentivized to use them like 401(k)s. HSAs have an advantage over 401(k)s in the sense that any withdraws for medical use after the age of 65 are tax free (unlike IRAs). If you do withdraw for personal use after 65, there is currently no penalty so at worst they are equivalent.

 

3. I don't think anyone is suggesting overall deposits will rise 20%/yr. Only that the HSA market is projected to grow by that amount.

 

The most recent HSA Industry report came out a week ago. Total D + I continues to grow. Individual admins will obviously be lumpier. HSA Bank did lose their #1 position with Optum Bank's acquisition and lost some market share.

 

http://www.devenir.com/devenirWP/wp-content/uploads/2016-Midyear-Devenir-HSA-Market-Research-Report-Executive-Summary.pdf

[vox]

It seems that HQY is a fintech company with a completely different business strategy and financial structure than WBS. You wouldn't just apply Chipotle's P/E multiple to every casual restaurant.

 

I think an independent HSA Bank would have a different investment portfolio and non-interest expense burdens than is currently being allocated as a division of Webster.

 

The deposit growth I was referencing is from page 40 of the Kerrisdale which shows HSA Bank deposits going from $9.2 billion in 2020 to $19.2 billion in 2024. Maybe they'll be able to do that, but it seems optimistic to me.

[Guest Schwab711]

I agree, there would be some additional costs from a separate management team and costs of being public, but HSA Bank's segment results should be a fair approximation. If not, it raises other issues. The difference in investment portfolios of HQY and HSA Bank (or Optum) is a bank charter, which allows them to hold/invest their deposits. I'm pretty sure HQY sells their deposits as brokered deposits to partner banks.

 

I'm not really sure what is special about the fintech label. HQY, HSA Bank, and Optum Bank are all HSA (ERISA plan) admins and custodians. They all do the exact same thing with slightly different customer relationships. HQY is different in the sense that they do not have a bank charter, which has certain consequences and benefits. HSA Bank and Optum are glorified banks that are more akin to traditional trust/custodian businesses. The real long-term money in this business is going to come from the interchange fees from customers spending their account balances, which is why I think being a bank is going to have an advantage. In the mean time, the regulatory obligations for HSA Bank and Optum Bank are more than offset by the NIM on deposits.

 

HQY doesn't seem to have any discernible technology or healthcare advantage over HSA Bank or Optum at present. HQY has low organic growth and their market share is almost completely due to acquisitions. HSA Bank has displayed above-average organic growth in many years, including recently. HSA Bank also seems to be the industry thought leader when it comes to publishing white papers and the like. If anything, I think HQY has a disadvantage in many areas of the business.

 

The deposit growth on p.40 is for HSA Bank only. The HSA market projections may be a little aggressive but there's reason to believe that 10%+ is reasonable for the next decade. See my comments on incentives combined with very low market penetration of these plans. Beyond that, Kerrisdale simply multiplied HSA Bank's market share at publication by the projected market size.

[Guest Schwab711]

http://seekingalpha.com/news/3208209-lender-calls-higher-rates-jpmorgans-dimon-speaks

 

This is becoming a near certainty. If not September, then it seems like it will happen by the end of the year. I don't know of a bank that stands to benefit more on a proportional basis then WBS. I believe each 25 bp hike lifts earnings by roughly 8%-10%, with AFS securities considered (~12% of assets v. ~55% of assets benefiting). Going forward, the benefit should be even greater. I'm not sure how much I can improve accuracy without having more detailed info, but I think WBS has a lot of tailwinds.

[vox]

I think you are drastically overestimating the effect of a 25 bp interest rate hike.

 

From the Asset/Liability Management and Market Risk section of the company's 6/30/16 10-Q:

 

"The following table summarizes the estimated impact that gradual parallel changes in income of 100 and 200 basis points, over a twelve month period starting June 30, 2016 and December 31, 2015, might have on Webster’s NII for the subsequent twelve month period compared to NII assuming no change in interest rates:

 

NII / +100bp / +200bp

June 30, 2016 / 2.1% / 4.3%

December 31, 2015 / 1.6% / 3.2%"

 

In other words, a gradual 100 bp parallel upwards shift in the interest rate curve would increase net income by $10 million per year after tax ($700 million LTM net interest income * 2.1% * (1 - 32% tax rate)), which is approximately 5% of their net income.

[Guest Schwab711]

I agree, way too aggressive. I should have considered the reasonability before posting. I also believe that the interest rate sensitivity table underestimates WBS's book. Among other things, these tables make very conservative estimates on cost of deposits and fed funds rate that I think underestimate the impact to WBS. I think these tables provide reasonable estimates for most banks. I may ultimately agree that it is reasonable for WBS, but I don't at the moment.

 

I definitely made a huge mistake by not factoring in the IR derivative book. They have a lot of hedges, which I should have assumed with such a large variable/commercial book. You are right that my above estimates for a rate hike are worthless. I need to spend more time thinking about this. I'm trying to make a more accurate estimate with insufficient data, so I expect to make many more mistakes along the way. Either way, the core thesis is still the HSA Bank holding which I still have confidence in.

 

One interesting point that I haven't mentioned yet and which could be a major risk at some point is the note that many of WBS's hedges are with their "customers" (and non-netted!). I'm becoming more confident that a lot of their commercial deals are with institutional investors (loan + hedge with II). It would explain the loan growth. Being HQ'd in CT certainly factored into this belief. I haven't seen any questions in CCs about it, but maybe I missed one. WBS could be highly exposed to a strong downturn in the US economy or commercial real estate (well above-average exposure). I think it would take a 2008-2009-type drop, but I have to spend more time thinking about this as well. Anyone have thoughts on whether I'm underestimating the risk here?

[Guest Schwab711]

WBS is probably my favorite LT play. It's not an overnight double but HSA Bank is an amazing asset for a regional bank. I think it will do well from here.

 

As mentioned, my original guess was nonsense. However, despite a flatter yield curve, 3 rate hikes have led to NIM expansion of 22 bps. It was driven entirely by and YOA expansion, primarily due to variable book, less rate cap hedges (COD was essentially flat). Offset slightly by decreased risk in loan book. The funding advantage seems to be very real. Most banks saw a double-digit bp increase in funding costs over the period. HSA deposits are roughly 24% of total deposits (from 22% at last post).

 

HSA Bank had a $75.6m EBT run-rate in 3Q17. JPM values HQY at 22x EBITDA (according to latest sell-side report). Not necessarily apples-to-apples but they would probably value HSA Bank in the neighborhood of $1.65b (approximately 33% of WBS's market cap).

 

Since the last post, total HSA deposits are up 22.8% to an estimated $44.7b

http://www.devenir.com/wp-content/uploads/2017-Midyear-Devenir-HSA-Market-Research-Report-Executive-Summary.pdf

 

Throw in a potential corporate tax cut and WBS has some nice potential catalysts.

[Guest Schwab711]

HSA Bank EBT run-rate is up to nearly $100m as of 1Q 2018. The operating leverage is starting to ramp.

HQY looks to be trading at ~55x EBT. Based on peer multiples, HSA Bank is roughly worth WBS's entire market cap.

Edit: I'll try to be a little more consistent here. HQY is trading at 35x fwd EBITDA. That puts HSA Bank at closer to $3.5b without adjustment for whatever D/A may be.

 

Efficiency ratio fell below 60% in 1Q 2018.

 

NIM expansion of 33bps y/y this Q. The majority of the portfolio is variable rate loans and a majority of deposits are roughly fixed around 0%. I haven't found a bank that is better positioned for the current yield curve and stated intentions of the Fed.

 

I still think WBS is the best long-term risk/reward play in the US. There are a lot of tailwinds at play.

 

1Q18 Presentation Slides:

https://webster.gcs-web.com/static-files/b4d3f28c-50a9-496b-98db-888982787f14

 

1Q18 Supplemental Slides:

https://webster.gcs-web.com/static-files/80c44016-14cb-4c73-bf15-0e25e2bd3d6b

[Guest Schwab711]

I don't think anyone is interested in WBS but HSA Bank's EBT is roughly 40% greater than HQY's, despite lower service/interchange fees charged. WBS has higher deposits/account and better organic deposit growth from existing accounts. On the most recent conference call, WBS confirmed that cost of HSA deposits would be 20 basis points for the foreseeable future (without any pushback) because their all-in fees are still the lowest in the industry.

 

At HQY's multiple (70x), HSA Bank is worth more than WBS's current market cap. At a more realistic 30x multiple for HSA Bank (considering growth profile and operating leverage in the near-term), Webster Bank trades for roughly 10x eps with above-average ROE for a regional bank (not the best way to look at WBS but it gives you some range of how WBS is valued at the moment).

 

HSA Bank continues to give WBS a lot of options on how and where to compete for deposits and to make safer loans because of their borrowing advantage over nearly every regional bank. Further healthcare reform is impossible to predict but there are many outcomes that lead to expanded use of HSAs.

 

WBS is a good value at roughly $55.

[Guest Schwab711]

WBS seems cheap at $47.xx. Cigna probably represents $2b in deposits and a slightly below proportion percentage of HSA fee income (due to the size of the partnership). If Cigna moves their HSA business away from HSA Bank to a competitor (only Optum, a direct competitor, and HQY have scale like HSA Bank) then it would probably lower WBS's EBT by $40m-$60m in higher interest expense and lower fee income. They would still be the #3 or #4 largest HSA administrator, trade at < 14x earnings, and ROE/ROTCE > 10% and 13%, respectively.

 

I think it's unlikely that Cigna would move from HSA Bank, though the economics of the current deal may shift towards Cigna. If that is the case, it may signal a change industry-wide for HSA admins, since HSA Bank already offers the lowest all-in fees of any major administrator. The up-and-coming administrator is Fidelity, which is offering $0 monthly fees. The resolution of HSA Bank/Cigna may result in another wave of consolidation within the industry. With or without Cigna, I think WBS is an attractive acquisition target.