Author Topic: WBS - Webster Financial  (Read 6425 times)

Schwab711

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WBS - Webster Financial
« on: April 02, 2016, 11:39:51 AM »
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

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Re: WBS - Webster Financial
« Reply #1 on: April 02, 2016, 12:56:31 PM »
Thanks Schwab, I wasn't aware HSA Bank was part of a public co.

Interesting.
Ben Hacker
Beaverton, Oregon - USA

Rasputin

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Re: WBS - Webster Financial
« Reply #2 on: April 02, 2016, 08:52:12 PM »
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. 

Schwab711

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Re: WBS - Webster Financial
« Reply #3 on: August 17, 2016, 09:41:37 AM »
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
« Last Edit: August 17, 2016, 09:43:44 AM by Schwab711 »

Spekulatius

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Re: WBS - Webster Financial
« Reply #4 on: August 17, 2016, 11:42:55 AM »
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.
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vox

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Re: WBS - Webster Financial
« Reply #5 on: August 17, 2016, 12:44:46 PM »
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

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Re: WBS - Webster Financial
« Reply #6 on: August 17, 2016, 01:01:31 PM »
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.
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vox

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Re: WBS - Webster Financial
« Reply #7 on: August 17, 2016, 01:22:50 PM »
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.

Schwab711

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Re: WBS - Webster Financial
« Reply #8 on: August 17, 2016, 02:32:41 PM »
@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

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Re: WBS - Webster Financial
« Reply #9 on: August 20, 2016, 11:10:16 AM »
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.