Webster Financial Corporation
Moat: 2/5
Understandability: 2/5
Balance Sheet Health: 3/5
Webster Financial Corporation is a regional bank and financial holding company, primarily focused on commercial and consumer banking and wealth management within the Northeast United States.
Investor Relations Previous Earnings Calls
The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.
Business Overview: Webster Financial Corporation (WBS) operates as a commercial and savings bank providing financial services. The bank primarily serves the New York metropolitan area, and its business divisions are organized around three major segments: Commercial Banking, HSA Bank, and Consumer Banking. Each segment has its own unique characteristics and target customers.
- Commercial Banking: This segment serves small and middle-market businesses, providing a comprehensive suite of lending solutions, deposit products, and various financial services tailored to meet the unique needs of their clients. Commercial Banking seeks to maintain strong relationships with regional businesses, particularly in the markets where the bank has a physical footprint.
- HSA Bank: This segment provides a broad range of health savings account and other related services. HSA Bank caters to a variety of clients, from individuals to large national employers. HSA Bank is a significant provider of health savings accounts, which has experienced considerable growth due to changes in healthcare policies and increasing consumer awareness.
- Consumer Banking: Through this division, Webster delivers a diverse array of personal banking products and services, like checking and savings accounts, loans, and mortgages. It focuses on building customer loyalty by delivering value-added services and solutions, including an increasing focus on technology.
Industry Trends & Competitive Landscape: The banking industry in the U.S., especially the regional banking sector, is increasingly challenged by technology-based financial companies, which are competing directly with traditional banks. Customers are constantly on the lookout for products that combine a user-friendly, technology-based experience with personal attention. As a result, traditional banks like Webster need to invest heavily in technology to maintain a good customer base, while still providing the human touch required by complex financial products. The cost of complying with regulation continues to increase, leading to higher operational expenses. The competitive environment has many players, and local / regional banks are battling the large national / international behemoths. Banks of all shapes and sizes are experiencing challenges in this space.
Financials In-Depth
- Revenue Drivers:
- Net interest income (NII) is the core revenue source, heavily dependent on the interest rates set by the Federal Reserve. The NII is the difference between what banks earn on their loans and what they pay on deposits.
- Fee and commission income is a large portion of revenue and comes from servicing fees from loans, brokerage accounts, and wealth management.
- While interest rates are higher in 2022/23, net interest income has increased substantially, especially compared to before the Fed started raising interest rates, the future trajectory of the rates and its effect on the balance sheet is unclear.
- Recent earnings calls and reports have cited higher than normal interest rate sensitivity.
- Lower transaction volume in their mortgage business due to increasing interest rates is putting a strain on fee revenues.
- A decline in overall loan growth in the last few quarters is another area of concern, this makes it tougher to increase revenue.
- The recent collapse of certain regional banks has put a lot of strain on market confidence.
- As the economy starts going into a recession, the credit quality of the loan portfolios is expected to decline, thus putting more pressure on the bottom line.
- Income Statement Analysis:
- NII increased sharply due to rising interest rates in 2022/23.
- The Company recorded a non-interest loss in their investments portfolio in the recent quarter, due to the increased interest rate risk, which negatively impacted EPS.
- The company’s revenue growth seems to be good, but there are concerns if these high-interest rates are sustainable.
- The company is trying to reduce overall dependence on their interest rate revenues and diversify their operations and revenue streams.
- Operating expenses have also risen over the past years, and efficiency remains a key concern.
- Balance Sheet Health:
* Recent earnings calls have shown a decline in deposit balances, due to the market searching for high-interest yielding avenues, thus forcing regional banks like WBS to compete harder for deposits.
* The company has a Tier 1 capital ratio of 9.5%.
* The overall quality of their loan portfolio is good, but higher interest rates and inflation will put more stress on consumer spending, and businesses might be more reluctant to invest and grow. * The bank's investment portfolio and their exposure to interest rate risks is a factor which needs to be monitored.
* The company also uses credit hedges to mitigate losses from loan defaults.
* The company's exposure to CRE has declined over the last few years. * The bank holds a substantial amount of securities classified as “available for sale” (AFS). Such securities are marked to market at the end of each reporting period, and any price changes are directly reflected in “accumulated other comprehensive loss,” which in turn affects shareholder equity. In a period of sharply rising interest rates, as we have seen in 2022 and the early 2023, securities lose a lot of their fair value which impacts the overall book equity of the bank. * In the near term, the interest rate picture is very volatile, which can cause lots of strain on bank balance sheets. * Although it is still a well capitalized bank, their tier 1 capital ratio needs to be a bit higher, because it provides buffer against economic downturns. * All other metrics for measuring liquidity seem decent, implying good coverage for loan obligations
Moat Analysis:
- Switching costs - For consumers, banking is a low-switching-cost service, although for business, the cost may be significant. People rarely change banks in general, unless their banking needs or location change, therefore giving the bank some degree of revenue stability. Also, corporate clients who need specific lending products tend to stick with their existing banks, since these relationships and lending terms are hard to replicate. WBS also offers treasury management services, which makes clients stickier, because these services become integrated with the client’s processes.
- Scale: WBS is a relatively large, regional bank that benefits from some advantages, like economies of scale and a diverse operational network. Its size allows it to compete better with large national banks. However, their scale isn’t close to the behemoths and this means they have lesser bargaining power with suppliers.
- Intangible Assets: WBS’s brand recognition in the New England region is a weak competitive advantage; this is based on its presence in a particular area. Further, WBS is not considered a leader in technology or banking innovation, therefore, this moat is relatively weak. They are continuously working on technological improvements but that will take time.
- Cost Advantages: Although Webster Financial tries to be cost effective, they are not operating at a substantially low cost, so this doesn’t give them much of a moat.
Moat Rating: 2/5. WBS has some limited and weak moats. While they do have some geographic brand presence, some customer lock-in and certain distribution advantages, its moat is not particularly strong or durable. The reliance on a few key assets such as NII, dependence on interest rates, and potential erosion from competition means it is an easier to overcome for competitors and make the stock less safe for investors.
Legitimate Risks:
- Interest Rate Risk: WBS’s net interest income is highly sensitive to changes in interest rates. Future rate cuts can affect revenue and valuation substantially.
- Credit Quality Deterioration: As the economy softens, there’s a high chance that a lot of loans in the company’s books can default, leading to losses. If there is a sharp economic decline, the credit ratings of the debt might be downgraded as well, thus increasing the risk further.
- Increased Competition: Increased competition from large, national banks and innovative fintech firms might lead to lower margins and less market share.
- Increased Regulatory Burden: Changing regulation might increase operating costs and affect profitability. New rules by Federal Reserve may affect how banks handle their financial risks and may force them to re-engineer certain systems.
- Technological Disruptions: The increasing use of digital banking and mobile payments is putting pressure on the banks to invest more in technology, to maintain their customer base. If the company is late to adopting new technologies, that might lead to it losing its market share.
- Acquisition Risk: Their merger with Sterling Bancorp poses various risks including management distraction, integration risk, and the potential inability to achieve expected growth/synergies from the combination.
- Customer Base Concentration: As the company has a high concentration in certain geographical areas, a downturn in the local economy can disproportionately effect the business’s performance.
- Funding/Liquidity Risk: As many clients have started withdrawing deposits from regional banks, in search of higher yields, it is putting more pressure on WBS and might force it to scramble for more expensive alternatives.
Business Resilience: Based on the above analysis, I believe this is a lower resilient business and is vulnerable to external factors. Management will struggle with higher interest rates, lower customer confidence, and an increasingly competitive banking environment.
Understandability: 2 / 5. While it is a traditional regional bank, the underlying mechanics are complex due to derivatives, structured notes, the Federal Reserve, and its influence on interest rates, complicated accounting standards, and various other factors. For a non-banking investor, understanding the financial health and operating dynamics of the bank is much harder to understand. While a business with a simple structure might be easy to analyze, the complex operations in the financial industry creates a challenge for anyone trying to understand.
Balance Sheet Health: 3 / 5. While it’s not an unhealthy balance sheet, there are certainly some areas to worry about such as increasing volatility of assets due to large amount of securities held as “available for sale”, risk to deposit flight and their exposure to interest rate risks. Their credit metrics are still strong though.