Associated Banc-Corp (ASB) 2005 Q2 法說會逐字稿

Good afternoon. My name is April, and I'll be your conference facilitator. At this time, I would like to welcome everyone to the Associated Banc-Corp second quarter earnings conference call.

(OPERATOR INSTRUCTIONS)

At this time, I will turn the conference over to Paul Beideman, President and Chief Executive Officer of Associated Banc-Corp. Please go ahead, sir.

Thank you very much and thanks to each of you for joining our call this afternoon. As you can see from our press release, our earnings grew $0.60 a share in the second quarter with net income of $78 million and on a full-year basis 155.5 million, up from124 in 2004. What I'd like to do, if I could, is just give you a few brief comments on loans, deposits, fees and expenses, because I think there are some issues that are worth delving into in each of these categories. And then I'll be happy to take any questions, and Joe Selner is here with me as well.

First of all, in loans: in the second quarter our loans in aggregate were up $130 million and commercial loans were up 146 million or about 7% annualized. And home equity loan was up 62 million, about 14% annualized. Inside the commercial loan bucket, C&I loans were really up significantly, about $230 million, with real estate construction loans up about $72 million with pay downs in the real estate portfolio of about $163 million.

And in the real estate portfolio, we feel good about origination and production and we think, in fact, that this year our production is going to be higher than it was last year. But we're also experiencing some pay down from existing portfolio as customers are aggressively pursuing long-term fixed rates and more favorable terms in terms of guarantees and the like. And in this rate environment, there are many entities that are willing to provide this long term-- and by long term I mean as far as 10 years funding-- at fairly aggressive rates and aggressive terms.

We are maintaining a more disciplined approach in this segment and are working hard to maintain our durations in the three to five-year range on these things, mostly around three years. With some exceptions, perhaps to five. But we feel very strongly in the cyclical business that this is not the time to get aggressive with long-term fixed rate, more flexible underwriting terms and I have talked to many of you about this over the last several months individually. And we can see this playing through.

As the yield curve steepens, these payoffs will go down as customers will be less incented to aggressively seek the longer term, lower rate funding that's available. And I don't think it really has to go up very much from here to get to that point. But we've seen more than one situation where customers are able to get 10-year funding when leases on the buildings that they're funding are in the six, seven-year timeframes. We just don't believe in the long run, in this cyclical kind of a business, that that's the way we ought to be doing it. However, as you can see, our C&I growth has been very strong and we feel good about that. A good portion of this -- a meaningful portion-- is coming from our small business initiative, which is helping the momentum here. So, we feel good about that.

On the deposit side, for the year you can see that the deposits are down about $700 million, and in the quarter, on an average basis, about 300 but point-to-point about 100. I thought it would be worth spending a few minutes on the components of this and it's very similar to what we talked about in the first quarter. On a year-to-date basis, which I think it's the best way to look at it all, the municipal deposits, which are fairly high cost, are down about $300 million. Importantly, as the interest rate environment has changed, about $200 million of commercial deposits have migrated from traditional deposit products into sweeps. This is the customer preference obviously when interest rates are moving up. So, we are trading in essence fees for balances.

The remainder is split between NOW account balances and CDs to make up the remainder. I would point out that, while it's a trend that we are going to work hard to fix, in the second quarter of last year our deposits were down on a seasonal basis, as well. And so, what we're seeing this quarter on a larger basis is similar to what we saw last year. As I said, the munis were down about 300 million. But if you remember, in the first quarter, from the third quarter of '04 to year-end, they went up about 300 million and now since then, they've gone down about the same 300 million. So those balances are flat to where they were third quarter of last year.

We feel good about the fact that our demand deposits are up about $100 million in the second quarter. And this is after the migration of those commercial balances that I was talking about earlier into sweeps. And we think that that bodes well in terms of momentum in this important category in the second half of the year.

We've hired a new Marketing Director and several key staff in the marketing area that's going to be focused in the second half of the year on continuing that growth, which has been an important strategic priority for us in the demand deposit area. But also focusing on other components of deposit. If we look at the seasonality trends and how we see the deposit portion of the balance sheet unfolding in the second half of the year, it's not unreasonable to think that that same $300 million of seasonality in the municipal deposits could be coming back.

We see the escrow balances that we talked about in the first quarter, about $170 million. We believe that we're going to see some additional, continued growth in the demand deposits buckets, even though there is some pressure -- continued pressure in commercial categories to move to sweeps of a couple 100 million.

Our NOW account growth that we've seen over the last couple of years, we believe, is going to be replaced by index money market growth. We have several products out there that are indexed to market conditions and as a result, the magnets, if you will, in those product categories are going to be stronger. And we think because of the trajectory of maturities and the marketing initiatives that we're going to allow, that the CD deposits will flatten out and also then begin to grow.

So there's a lot going on in deposits, but I wanted to spend a couple of minutes talking about what the dynamics were and where we see that going. In terms of fees, we feel really good about what's been going on here. Our trust fees and commissions are up significantly, both on a linked-quarter basis and year-over-year. And First Federal really has little or no impact on these two categories. You can see that both the commissions and trust fees on a year-over-year basis are up double-digits.

Deposit fees are really also remaining strong and are up about 19% from the first quarter. This is a function of several things that we've done from a pricing point of view, but it's also the realization of the associated fee structure against the First Federal deposit base, and importantly, our ability to keep that base. And that's the momentum. We feel good about that through the rest of the year.

Mortgage income from sales, the revenue component, if you will, is basically flat to the first quarter. But we've had about a $7 million swing from first to second quarter in MSR valuation. There is $2.5 million recapture value in the second quarter, which is affecting, certainly, the mortgage business. We feel good about originations going into the third quarter, and depending upon how the interest rates are moving, which they seem to be doing now, there is the possibility for potentially recapture.

On the expense side, we have, I think, really made some significant progress, and our expenses were very strong in this quarter. The staff expense is down approximately $6 million over the first quarter. This is a result of us having reduced our overall headcount from the beginning of the year by about 10%. We feel good that this benefit is going to be sustainable for us going forward as a result of that headcount reduction. In fact, there's about -- well, there is slightly over $1 million of severance expense associated with this exercise embedded in those second quarter numbers. And much of the headcount really didn't leave the organization until we got into June. So, we feel that there is some continued momentum there.

Some of that reduction can be offset, certainly, as revenue increases in the second half of the year with commission-based compensation and the like. Obviously, when you are focusing on this type of an initiative, where you're reducing your headcount by about 10%, you remain somewhat inwardly focused during that period of time. But we're looking forward to having this behind us at this point and really focusing on our strategic priorities and some of these marketing initiatives that we've talked about. And taking advantage of the attractive market and the in-store system that we've acquired.

So, in a nutshell, I think that covers the important components from my perspective. We'd be happy to answer any questions that you have.

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Thank you.

The first question comes from the line of Ben Crabtree with Piper Jaffray.

Good afternoon.

Hi Ben.

I was just wondering, Paul, if you could comment a little bit about the margin trend, the outlook. Obviously, you've already commented about the competitive nature of what's going on. And I guess, implicit in what you're saying, is that the volumes may be affected more than the pricing. But I just kind of wondered what you're going to say about that what you might say about the outlook for the margin over the remainder of the year.

Sure. It think what we're continuing to see and will probably see, at least in the next quarter, is the effect of this pricing pressure on things. Especially if the yield curve remains relatively flat. Everybody is talking about the flat yield curve and a year ago we were all talking about asset sensitivity. And I don't want to give the impression that if the yield curve normalizes, that the margin is immediately going to spike. I think what we're seeing right now is that customers are focused on getting paid aggressive deposit rates on the short-term, almost on transaction balances. And on the loan side, they're looking to extend as aggressively as you can to get long-term fixed rates.

If the yield curve normalizes then those trends start to normalize to, where the lending will come in the curve and the deposits will move out. And then the margin begins to expand at a healthier rate. So, I would say that we saw about a 5% or five basis point deterioration. It's not unreasonable to think that over the third quarter, we could see something similar to that.

Okay. But it's sounds like, how do I phrase this correctly? But within a certain duration of loans or things like that, it isn't that the pricing is necessarily so crazy. It's just that people are willing to go out longer than you are.

Certainly, that's the case on the real-estate side.

Right. And something you said it -- sounded to me like it might be non-bank competitors. Did I read too much into that?

I think it's a combination of some bank competitors, but also insurance companies who have a whole different model here and RIETS and conduits, passing business through. In this environment, there's an aggressive-- but it is customer driven. In this environment, if you can extend for long-term fixed rates without guarantees and pre-payments penalties, I mean...

Okay. Thank you.

Your next question comes from line of Marsella Martino with KeyBanc Capital Markets.

Good afternoon

Hi.

Can you just expand upon the commercial loan growth, pretty strong there. Can you just talk about a little bit, where it's coming from and what you're seeing in your markets as far as the economic conditions?

Yes. Our markets aren't boom bust, but we're seeing I think some increased demand on the C&I side. And we've been talking for the last couple of years about getting our small business operations up to speed, so that we can be getting our share. And we're beginning to see some of that come through. And we're happy with what we've been able to do in Milwaukee. Certainly, we invested in putting new business bankers around our stronger distribution systems in Madison and in Minnesota. And our Chicago franchise continues to be strong, more on the middle-market type of lending. So we're seeing all of those components contribute to those growth levels.

Okay. Then (inaudible) deposits, they bounced back nicely this quarter. Any sense for on the outlook for the rest of the year? Do you think that this is sustainable at this levels?

I would like to think that the demand deposit growth could be sustainable at those kinds of levels. And that's as the interest-bearing deposits are going to improve, partly from some seasonality effect. But mostly from our ability now having gotten through the first federal conversion successfully and now this fairly significant workforce initiative that we've been focused on for the last couple of months. That we can start our in-store system and to the investments we have made in some of these markets to -- and some more aggressive external marketing-- to change the run rates there.

Great. Thank you very much.

Sure.

Your next question comes from line of Mark Kehoe with Merrill Lynch.

Mark?

Mr. Kehoe, your line is open.

Hello. Hi, everyone.

Hi.

My first question is in terms of the loan pipeline, whether you can give us any indication of depth?

Sure. The CNI pipeline continues to be strong. Our home-equity lending continues to be strong. On the real estate, constructions component, the core business of going out there and doing the project lending and the management of all that -- that's very strong. And I think it's going, as I said earlier, it's going to be stronger than it was last year. The issue is going to be around the velocity and duration of the timeframes around some of these competitive factors that are affecting the more mature components of the real estate portfolio. So there could be some drag there, but I think -- my view is that that's going to start to wane as we go to the rest of the year. But it's difficult to predict exactly where those interest rates are going to be.

And then a second question in terms of the credit quality. The increased non-performing assets, whether you could talk about that for a moment please?

Yes. First of all, our absolute credit loss has remained very strong about the 3.6 million, was up slightly, but still you know well below 20 basis points. And we had a pick up in non-performing loans. And in that sense, I mean there has been upward and downward movement and in and out to smaller credit, but that's really one credit that deteriorated through this period that we're going to spend time working through. I think what we are going to see both in terms of charge-offs and non-performing credits is that they're going to stay in a fairly tight band. And you know I always give the disclaimer that you can be surprised in these things. But we think we are going to have, be up and down in a fairly tight band over the next couple quarters.

Great. Thank you.

Your next question comes from line of Scott Siefers with Sandler O'Neill.

Good afternoon, everybody.

Yes. Scott.

Just a quick question. In the press release you talked about if having the challenging revenue environment on the flip side, cost control as well. I guess if you - I think you've said that there is about a million in severance charges embedded into the second quarter numbers. There's about $115 million run rate in terms of non-interest expenses. I'm just curious about, what do you think that you can lower that on an absolute basis so where you would see costs trending over the next couple of quarters?

I don't know if we can lower it on an absolute basis much more than we have. But I think -- I'd like to think that it's going to normalize out at these levels, and that's a -- especially that staff savings. Although it's quite aggressive in the second quarter, it could bounce back a little bit. But I think most of the savings there are sustainable unless revenue is driving variable compensation components of it. So, over the next couple of quarters, we think that we've changed the run rate there substantively toward those numbers that you are seeing.

And this cost management thing, especially in this environment, is something that we have been working hard at to make work us a core competency. And we've been working at this over the last few years, and just sort of quietly going about our business here in terms of trying to make sure we've got resources allocated to the right places. We've reduced the headcount 10%, but at the same time we're hiring into some of these more attractive markets, like Madison and Rochester and Minnesota and in Chicago, to make sure that we've got the bankers and the wealth management resources and brokerage around the branch system that we've picked up to make sure that we can generate those new revenue sources. So we're investing as well as trying to manage the cost.

Okay. Thank you very much.

Your next question comes from Eric Grubelich with KBW.

Hi, Good afternoon. I have a couple of questions for you both. I think you just may have just answered one of them. On the expense side, is it fair to conclude then that your staff expense, this is as low as it gets.

We'll always keep looking to find ways to be more efficient. But I think in terms of meaningful additional reductions right now, this is as about as low as we're going to go certainly this year.

So I guess what I am trying is that the 10% headcount reduction, that was the plan, that was done...

Yes.

Homework, there's no tail to it?

Correct. That's right. We spent an awful lot of time looking at each business and thinking about where we wanted to go and the adds and the subtracts. And if anything, it can bounce back slightly from this if we continue to invest in some of the growth markets. But it's not going to bounce back half of it by any stretch of the imagination.

You made that clear. That's good color. The second question I had, maybe for Joe. Is there any other First Federal related restructuring or integration charge that is in the numbers, that any place else that we might want to consider?

No.

Okay. That's a good answer. And then maybe, one more question on the revenue or two more questions on the revenue side. You made the comment about the deposit service charges, in essence overlaying the associated framework onto First Federal. Was there anything else in there with respect to your core, the non-First Federal customer base, in terms of fee schedule changes or anything like that?

Small ones. We've done some things with things like safe deposits and some other areas. But the other big variable I would say is making sure that we are capturing the fees that we are entitled to and knocking waivers down. It's a management process that we've been working on for some time and we're starting to see it just begin to take hold the little bit right now, in terms of check charges, safe deposit fees, overdraft fees and the like. Making sure that we've got discipline built into the process. And we're seeing a few percentage points of changes there in some of these large fee categories as the positive affect. So, its not substantive pricing increases. It's more just execution on getting paid for the fees that we deserve.

Okay. And then one other question on the revenue side. Again, not huge in the scheme of things but you had a little bit of a lift in the trust revenues. I know you folks have been wanting to grow that business for quite some time and it's been a little bit sluggish, at least through '04 it was that way. Is there anything new that has developed there, either customer wise, fee wise, or maybe accrual of fees this quarter from a timing perspective?

No, I think I'm -- I would like to think that it is again selling effectiveness. And there are markets like Chicago where in 2003, we weren't doing very much of all frankly. And we could do much, much better given our private banking position down there. So we've invested in people, and it takes a while for that stuff to take hold. We are investing in people in Madison markets now and in Minneapolis and we would like to see those kinds of trends continue. And it is largely through selling effectiveness and increasing the cross sell capabilities from a commercial business into wealth management but also into insurance businesses. And some of the lift that we're seeing there is the result of those cross sell initiatives as well.

Okay. Thanks very much.

Your next question comes from the line Joseph Stieven with Stifel.

Hi, guys. I had to join a little bit late, so I don't know if you covered this or not. But you're C&I growth was very strong. I heard you talk a little bit about the commercial real estate coming down. But was there anything just in general feeling to C&I growth? I mean, obviously, the markets are starting to improve in the Midwest but that seemed to be even better than we were expecting or maybe even better than what you guys were expecting. So could you just give us some color there?

I think we are starting to see some increased demand. I mean, I don't know if it is going to stay at that level for the rest of the year. In fact I would suggest that it probably isn't. It's going to be healthy. And it is, to some extent, offsetting the other issues that I talked about in terms of not matching some of the structure things that are going in the real estate side equation. That's good news for us. I want to make sure our commercial portfolios are growing. But I think the growth trends are going to be strong but I can't sit here and say that they're going to be as strong as they were in the second quarter.

Sure. Okay.

But it feels good. The market it seems to be some level of growth and traction.

Okay. And on the commercial real estate side, the business that is getting priced very aggressively, is that being done by the non-banks or are you seeing banks actually do it?

We are seeing banks do it. And interestingly, a good portion of it are smaller loans, like 1 million, 1.5 million. That's the sort of thing. So it's also smaller banks. So it's a little surprising when you get in and really look at the details of it, which we've done over the last couple of months. And I mean there are some large, notable transactions and those are probably more toward the insurance companies. But there are banks -- I'm going to say about 40%, and Joe can correct me, is about 40% of that outflow is loans under $2 million in size.

Okay.

So there is small institutions aggressively pursuing these kinds of deals.

Okay. Good quarter, guys. Thank you.

Thanks.

Your next question comes from line of Brad Ness with FBR.

Hi, guys. How are you doing?

Good Brad. How are you?

Doing good. A couple of quick questions, with the FTFC transaction, I was thinking that originally the cost savings were going to come partially this year, and maybe 60% next year and about 40% next year. And it seems as though the 60% this year is probably taken care of. Are you still looking for maybe 40% cost savings in 2006?

I think the way you need to think about it is to -- there are so many moving parts. We are adding and subtracting all the time. I think the way to look at this is the headcount line is the clearest indication of what's going on and the efficiency ratio. If First Federal's efficiency ratio was 60 and ours was 50, and we reduced our headcount by 10% in aggregate and gotten the efficiency ratio back down to 50, I would suggest that the lion's share of all the savings are pretty much baked in.

Joseph Selner Brad, I would comment that the reason we put 60% down is because we knew the conversion was going to occur in the first quarter and that we were going to loose 25% of the opportunity just by the calendar, not because we didn't think we would be able to get it, just that we were getting 12 months in it.

Okay.

I am very impressed with how the management team stepped up to the challenge, to be able to get at this kind of initiative in these times frames with that level of focus. And I think it made me feel good about their commitment to attacking this aspect of the business.

Would you say that the cost savings have exceeded expectations?

I would say that the timing of the execution exceeded my expectations a little bit. I was more of thinking that it was going to be phased in over time. As we started to look at it, looked at what we needed to do in this environment or what we could do, it has gotten executed in a pretty tight timeframe.

Sure, a couple more here. You know in other expenses, looks like there's around 21 million versus around 17 million in the first quarter. So, pretty big swing of $4 million. Is there anything that I need to know about it in there that's maybe not recurring?

I can't give you a specific answer. I can pick up -- I got to -- I mean I'll have to go back and look at it because I can't come up with those numbers either.

And I'm going to ask a similar question on the other income, too. Looks like in the second quarter, other income was 6.4 versus first quarter 4.8, so a decent amount, more than what I was looking for. Is there anything other that you can think of there that's maybe non-core?

There's not any large thing to jump out. It's always little things going on all the time. I'm going to have to go back and look at that, Brad. I can't -- nothing comes to mind that's a big deal. You might see a million here and a million there kind of things, but they're all over the place and income statements. I can't come up with something and say this is why.

No problem. I appreciate that.

The next question comes from the line of Peyton Green with FTN Midwest.

Hi, good afternoon.

Hi Peyton.

I was wondering if you could talk a little bit, Paul about the initiative to get the sales I guess environment of the company up. I know it has been and I guess it's going up on a second year and things like that are really saw some great leverage in the quarter, but where do you think you are versus where you want to be? You think you are a third of the way there, or half way there? Can you give an idea of what's or when we might see more progress on that? And then secondly, Joe, for you, would you all look to do any type of bond portfolio restructuring now that the loan deal has gone a good deal a blow where the investment yields are and maybe operate with the four smaller balance sheet, maybe buyback stock with some of the balance?

I will let Joe think about that when I'll talk about sales for a minute. There are several things going on. Around this restructuring, we've also taken the opportunity to bring some new people into the organization. We have serve 18 months through this whole process, and everybody is given a chance to play but we needed to strengthen the management team in some ways to around focusing on sales more aggressively.

And we've positioned, certainly, some existing employees at it in new roles but also brought some new people into it to add more ways. It's imperative, it's important to us strategically that we begin to see some real lift from this stuff in the second quarter, as -- in the second half of the year, as we move into this more external focus coming out of this whole staffing initiative analysis.

We've invested time and effort in continuing to improve the in-store system. I have hired, as a consultant, the lady that used to run the in-store systems for me, and now I must retire, just to help focus on the selling effectiveness from that important channel for us. So we've added a lot of new people. We've bolstered up our commercial capabilities and our wealth management capabilities in Madison.

We've got this in-store channel that we can exploit. So I am very hopeful that in the second half of this year, in those businesses, we're going to start to see some real lift. And we have been seeing it, to some extent, in some aspects of the commercial business and in some aspects of wealth management that we were talking about earlier.

Okay. So I mean it's fair to say that you're done with the assessment part of it in your path two-thirds of the way through the implementation, and now you've have got to execute along the way.

I think that's very fair.

Okay. Good enough.

And in terms of the investment portfolio, nothing's out of our thought process. We think about those things everyday. As you and I've talked before, the duration of our investment portfolio is very short. We have a lot of cash flow coming in. So it's -- we don't -- I don't see us doing any thing for dramatic -- drastic like that, but we continue to think about opportunities. And so we're -- we just keep looking at it. But there's nothing that I can tell you, right now, we have in mind.

Okay. All right. And then, Paul, in terms of integrating State Financial down the road, how does -- I guess what, are the obvious things that you all will do with it, once you've bolstered onto the system? And thank you.

We didn't hear the question.

Well, what's that you add on State Financial? Where you're looking to exploit their franchise versus what you've done with First Federal?

Okay. I think the value that they add is similar to what the potential was for First Federal by strengthening us in -- well, certainly, in Milwaukee, where we have a major presence. So there, it becomes just execution. By also moving into this new market, which is in Northern Illinois suburbs, above Chicago, which is a brand new place for us. So again, they were a good commercial bank. And over the last few years, they've hired in some very good people on the commercial side of that company. But we've got the ability, I would like to think, to enhance -- again, post-systems conversion and all that -- the retail banking capabilities and wealth management. But since we are bigger, we have got the ability to lend more money and deal with more with larger companies in that attractive growth market. So we'd like to think that that creates a prospect for us to grow revenue from these more diverse sources at a greater rate than we otherwise would.

Okay. Anything you are disappointed with that you all haven't done quite as well as you would have thought over the last six months?

Yes. I -- well, I am not happy with the relative position, where we are on the deposit front. And like I said, we had this seasonality thing for two years in a row. That's one of the reasons why we went out and hired this new director of marketing and a few people work for her as to make sure that that doesn't happen next year and that we change the trajectory on the deposit side. That's an important strategic priority for us and I think that's something we need to do.

Okay. Great. Thank you very much.

I would like to -- before we go to the next question, I would like to go back to Brad Ness's question and Brad, if you are still on the phone, we can -- maybe you can hook back in again. I think that the comparison you were doing was second quarter of last year to second quarter of this year. And of course that's all being affected by the acquisition of First Federal. And that's why I think I was confused on your question. If I'm not getting that right, you can let me know. Okay. Thank you.

(OPERATOR INSTRUCTIONS)

Next question comes from the line of Eric Grubelich with KBW.

Joe, I was looking at that expense line as well, and I think what might have confused me about the number you reported for the quarter was, I thought last quarter you made a comment that in other expense, there was like $3 million related to integration charges for first half.

Yes. That's right. But I think I can see where the confusion is.

Yes.

It's in other expenses, but it's sort of all over the place, it's not in that one line.

I got you.

And if we probably said other expense and there was a line called other expense sort of buried in half dozen expenses.

It was up quite a bit from the fourth quarter. And I do understand how you get the blend of the acquisition -- the timing of it that influences the numbers, so...

We weren't precise enough in our comments. It deals with data lines and a lot of different things.

Okay. That explains my issue. Okay. Thank you.

At this time, there are no further questions.

Okay. Well, thank you all for your time. And we appreciate your participation.

This concludes today's Associated Banc-Corp. second quarter earnings conference call. You may now disconnect.

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