Associated Banc-Corp (ASB) 2006 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen. My name is Stacy and I will be your conference facilitator today. At this time I would like to welcome everyone to the Associated Banc-Corp first-quarter 2006 conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period. (OPERATOR INSTRUCTIONS) Thank you. It is now my pleasure to turn the floor over to your host, Mr. Paul Beideman, President and CEO. Sir, you may begin your conference.

Thank you very much and thank you all for participating in the call this afternoon. As you can see from our release we earned $0.60 per share in the first quarter of 2006. But obviously there's a lot going on that impacted our first-quarter results both positively and negatively. And our actions in the first quarter I think will also have a substantive impact on the remainder of the year. So what I'd like to do is briefly describe the results but really focus most of my remarks on the future and how our actions in the first quarter position the Company going forward and then we will be happy to take any questions that you have. And as usual Joe Selner is here with me as well.

Let me start if I can with the net interest income and the margin. In the quarter we saw the margin declined by 11 basis points and the result in net interest income declined from fourth quarter and remained essentially flat to be first quarter of '05. About half of the decline can be attributed to the seasonal flow of demand deposits and free funds and you will recall that the margin declined about 6 basis points in the first quarter of '05 for essentially the same reasons. These balances will recover and in fact are recovering and will grow.

The absolute levels of demand deposits at the end of the quarter are up 7.5% from a year ago and we're seeing the recovery from a seasonal point of view of those balances. The remaining decline in the margin is a result of a combination of factors, the yield curve, competitive pricing certainly but also yield on investments as compared to the cost of wholesale funding and how those dynamics changed in the first quarter.

Late in the quarter we accelerated our initiative that we had announced in the third quarter to reduce wholesale funding and the acceleration to perform of selling $700 million of investments and then buying back 4 million shares of Associated stock. As a result of the interest rate movements in the fourth quarter and in the first quarter of '06, the investments that we sold were approximately 80 basis points underwater at the time of the sale to the comparable wholesale funding costs. This was a very different position than existed in the third quarter of '05 when we announced the phased deleveraging and was an important variable in our decision to accelerate that deleveraging in the first quarter.

The result of the transaction will be as a result of what I just said, improved yields from our investments, a lower cost of funds and a resultant improved margin.

In hindsight could we have executed the transaction in the fourth quarter or should we have? Absolutely. If we had, our margin would have been essentially flat in the first quarter even considering the decline in demand deposits. But in the third quarter when we announced the phased deleveraging, the Fed Funds rate was around 350 and from our view and I guess many in the outside world we anticipated two more increases. In the first quarter we were at 450 and anticipating two more increases. And again those variables drove our decision to accelerate.

Importantly though I think we were able to execute the transaction without taking a charge to the Company's earnings. And we feel good about that. We'll continue the phased deleveraging through '06 toward the goal of a $2 billion reduction in wholesale funding by year end all other variables being equal. And we've completed, as we said in the press release, slightly over $1 billion of that initiative thus far.

Continuing to talk about other variables that are impacting the margin, loans grew over $300 million or 9% annualized in the first quarter with strong performance in C&I lending and home equity lending. Deposits also showed some good performance especially in the interest-bearing categories with the seasonal decline that we have seen in the past occurring in commercial DDA. So if you look at the first quarter of '04 versus on -- sorry-- '05 versus '06, the dynamics there really are different. Deposits grew in absolute terms and interest-bearing deposits grew over $250 million where there was a significant decline in absolute deposits in the first quarter of '05. Loans grew about 40 or $50 million in the first of '05 versus $340 million in the first quarter of '06. So we feel pretty good about the dynamics there.

And from a sales perspective, I think that the first quarter of '06 really has been the best quarter that the Company has had, at least in my three years. If you look at the activities and what is driving sales performance, our new checking account openings are up 30% across the system and 50% in our in-store banking system. And importantly over 90% of the accounts being opened are interest-free accounts.

Net accounts are also up significantly in these categories and we've seen positive net checking account flows for every week but the very first week of the year in the quarter.

Small-business DDAs are up over 25% and small-business loan volume which is emanating from the branch system is up over 50%. And again, we've seen strong C&I momentum with better deposit account penetration out of the commercial business than we have seen in the past.

Our insurance new business production which is being fed by referrals from our business banking operation as well as the core business of the insurance operation as defined by new commissions is up over 100% in the first quarter. So I'm seeing some good sound momentum around the new product initiatives that we're putting out, the sales processes that we're putting out and the benefit of being in these stronger markets. And so from a sales point of view and a sales management point of view which is beginning to translate into some important volumes for us, we feel pretty good about the momentum.

As a result of all this when you put it together, I'm hopeful that the margin will improve significantly in the second quarter back toward year end levels as a result of the deleveraging, as a result of the loan growth that we're seeing in the first quarter which we believe should be stronger through the rest of the year. And coming from the right categories, our C&I loans and our home equity loans are growing in the double-digits and we think we can sustain that type of volume and our real estate lending should show some growth this year as the payoffs that we have been seeing in that portfolio have begun to stabilize.

Deposit growth showed also stronger. We're going to see positive seasonal momentum as the DDA balances recover as they did in 2005 but also enhanced balance growth in DDA categories and in interest-bearing categories as a result of the new products, better marketing and the better markets. We also think that the spread is going to improve as we focus on managing loan pricing discipline more effectively and having a greater portion of those commercial loan volume come from those small-business categories. And again if 6 basis points in decline of the margin in the first quarter of this year and in the first quarter of last year came from the seasonal decline in demand deposit, the recovery of those demand deposits and the growth should be a positive in terms of margin momentum.

We also believe that well in the first quarter we rolled out some of these indexed products at the more aggressive marketing approach and used some aggressive rates to get our name into the marketplace and to get our presence there and we had the ability to manage the costs of those deposits with more discipline going forward as well.

Changing over to fees quickly if I could. And really I know the margin really is the big topic and I wanted to spend as much time there giving you as much information as I could. In the fee categories if you look at our history the first quarter is usually the most challenging. And we show improvement through the second, third and fourth category or fees in fees in our core categories. Mortgage banking in the first quarter was a disappointment and a significant difference from the fourth quarter and from the first quarter of last year. We expect to see that improve as we move into the second and third quarter from seasonal effects but also from the effectiveness of our selling.

But in the first quarter, we've felt pretty good about where we came out in terms of our core banking fees, our trust brokerage and assurance fees as well. So if you take the mortgage piece out of the equation, we felt pretty good about where we were there especially as compared to first quarter of 2005.

Expenses remained strong. They are well controlled and they will continue to be well controlled. Asset quality is at still historically strong levels we believe. Nonperformers did increase slightly but our ratio of .71 is the lowest in nine out of 10 of the last quarters that Associated has had only beaten by the fourth quarter of '05. And the Company has grown in size significantly throughout '05 and while it did increase slightly from fourth quarter '05 levels it is still at a level that compares very favorably on a ratio on a percentage basis to all prior quarters for the last three years.

A quick comment about taxes. We did release tax reserves in the quarter as a result of closing out several years of tax audits with different governmental agencies and we also importantly reached what is a confidential agreement with the state of Wisconsin and I really can't say much more about it than what we have said in the press release except to say that it does remove from us we believe an unknown factor, if you will, a potential unknown risk in the future that has been mitigated as a result of the agreement.

Importantly, we announced today also that we've increased our dividend for the 36th consecutive year to $0.29 a share which brings our payout rate to about 48% and we're happy to be able to do that to provide that benefit to our shareholders.

I'll be happy to any answer any questions that you have. But I really wanted to try and give you some flavor as to where we see things. There is certainly risk in everything that I have said but we believe that we are well-positioned and we've positioned the Company in a healthier fashion as a result of the actions that we've taken here in the first quarter to enhance our performance in the second quarter and beyond. And that we feel good about the momentum that we're seeing from some of these core activities around improved product offering, sales management within our system and beginning to see some of the payoff from the investments that we've made to improve our distribution system and cross-selling capabilities in some new attractive markets.

So with that, Joe and I will be happy to answer any questions that you may have.

(OPERATOR INSTRUCTIONS) Eric Grubelich from KBW.

Good afternoon. I have one or two questions for you. First one is about the tax situation. And I know you can't talk about it because the WDR makes everybody sign a confidentiality. But --

Thank you.

Yes. I guess the liability that you released, was that related to -- you mentioned multi-jurisdictional. Was there something else besides the agreement with the WDR that allowed you to do that?

It was the lion's share of the catalyst. As you go through with the federal government and the state, there is a variety of tax issues that are out there for several years and, yes, there was more than --

Okay. That is fine.

In fact, there was reserves created, so it's an in and an out kind of a thing all of the time.

Okay. And then the other question that is really related to this because I've seen this at a couple of other banks. The impact of the settlement and these discussions, will this lead to a change in your effective tax rate going forward? You've take typically been around 32% --

No.

-- not going to change?

No.

Okay, so that is still a good guidance related number then, 32%?

If you took the last -- well, it's been up and down over the last three years. We've had years where it has been in the high 20s and we've had this last year was almost 32. It's a function of all those moving parts.

Okay, that is fine. Let me switch gears for a minute. Mortgage banking. I was a little bit surprised with how much that got squeezed this quarter. And now, Paul, you mentioned seasonality which I think is probably at banks will have that in the second quarter. The spring is always a good time to sell houses. What are you really doing differently on the selling side that you mentioned to improve that figure?

And then with regard to the shortfall this quarter was it something related to volume or spread or both? And was servicing a factor at all? I know you had -- you did disclose what the MSR related I think reserve change was in the press release.

If you compare to prior quarters, you will see that a fairly substantive portion of the difference is related to, well, you'll recall the sale of servicing in the fourth quarter of last year and a rather substantive MSR recovery in the first quarter of '05 that didn't occur this time. So there is substantive impacts from that. But the thing that disappoints me about it is the volume. And what we've done to change it is -- well first thing we've done about three weeks ago is replaced the head of our sales organization and put one of our very strong retail salespeople in charge of the management of the sales force. We've also been hiring in and frankly that has taken longer than I would have liked to get the sales force stable and positioned in the right markets.

So it's a matter of execution and we feel better about the execution going forward, the interest rates do sort of create a bigger hurdle. But there's going to be some seasonal benefits. But I'd really like to think there's going to be some performance benefits especially having changed the management structure of the thing too.

So you've got new leadership, you've got -- you also said you've hired more people, did I understand that correctly?

Yes. We flushed out our mortgage sales operations in markets like Minneapolis and others that are important to us that we needed to finish this transition between what the hybrid thing between what First Federal and Associated had to get the fully dedicated mortgage origination capability into these markets.

And on the gain on sales spread, was there anything unique there with any kind of hedging that may have been a little bit ineffective, ineffective is the wrong word I guess but -- just got a little sloppy this quarter because of the way the rates moved?

No, Eric, there was nothing on the hedging but we do have to the commitments and we do have the mark the closed loans and those were negatives to the quarter. So there is something there.

The other point I wanted to make sure you understood because I think you hit on it is because we sold the servicing in the fourth quarter, there's between 800,000 and 900,000 less servicing revenue in this quarter.

No, I assume that given what the volume you kicked out. Yes.

So that is another piece of it.

Okay. Okay. Good, thanks very much.

Andrew Marquardt from Fox-Pitt.

Hi, guys. Can you clarify the marginal outlook? Did I understand you right that you're expecting the margin to bounce back up in the second quarter or is that a more gradual outlook?

No, I think it's going to bounce back up in the second quarter; to what level I have to be a little in precise because of so many moving parts and external factors that can affect it. But how fast are the demand deposit balances going to recover? But if you think about it we sold $700 million of assets that were in essence underwater very, very late in the first quarter. It didn't occur until the 20th of March. So the impact in the first quarter was really pretty small, negligible. And we will have a full quarter of impact of lower borrowed funds and a higher yielding investment portfolio.

So if you look at the number -- the margin itself that number will improve. The asset size is smaller but I also believe that net interest income in absolute terms is going to improve as well because of some of the variables that I mentioned earlier. We have $300 million plus worth of loan growth in the first quarter. If we can maintain that an even do maybe a little bit better than that, there is momentum there to create loan growth. We have deposit growth in the first quarter if we can maintain that then that adds to net interest income.

Demand deposit growth on the consumer side was positive in the first quarter, the seasonal outflows are on the commercial side, those balances come back. And if we can improve growth that adds potentially to the momentum for net interest income. So I think in real terms, the net interest income number is going to improve as well as the margin numbers.

And what gives you confidence that the commercial DDA can bounce back? Is there anything that would tell you that perhaps there is some structural change that perhaps corporates are now using some of their cash balances?

I believe that that was probably more the case last year when interest rates were very, very low and started to move up. And I think we did see some of that dynamic last year. But in my mind there is very little risk to the structural movement of those balances. If they went down $175 million in the first quarter and then tax payments are made and that sort of thing, then the money starts to build and recoup itself in the second quarter and then throughout the rest of the year. And then really accelerates in the fourth quarter.

The issue that we have, the opportunity that we have is to grow more [core] check and balances. And on the consumer side some of the numbers I talked about before are really beginning to show some sound solid progress there and we need to continue to work on that within our commercial businesses to change those dynamics the same way.

Okay. And so after that kind of recovery in the second quarter do you think the margin should hold or actually improve?

Well we're going to continue to work the remaining portions of our delivering deleveraging strategy and we're going to work very, very hard to maximize the spread between our deposit products and loans certainly. We remain in an intensely competitive loan pricing environment and with interest rates flat or inverted; the cost of deposits is driven to the very short end of the spectrum and from an interest-bearing point of view. To the extent that interest rates move and provide more flexibility there, there will be more price flexibility on both sides of the equation.

So there is a range in that discussion. But we'd like to think that we can manage those spread dynamics more affectedly. If you look at our portfolio over the whole year, go back to the first quarter of '05 and the first quarter of '06, loan yield and deposit yield have moved essentially the same amount of money. The dynamic is that in the first quarter it moved more toward from the liability side than the asset side even though for 12 months it ended up at about the same place. So the first quarter was an interesting dynamic because of the inverted nature of interest rates during the time and obviously some of the decisions that we were making to position our deposit products.

Great, thank you.

Terry McEvoy from Oppenheimer.

Good afternoon. A couple of questions just looking at your comment in the press lease about the slight increase in consumer related losses. You referenced higher short-term rates and then you make the statement that you anticipate the trend to moderate. Rates keep going up I'm wondering what gives you comfort in seeing those trends moderate?

Well because we have begun to from late last year and we've really taken some steps to more aggressively manage the delinquency and loans as they are moving through the system. So we've upgraded our capabilities I think internally in terms of managing that. And frankly we saw some increase directly associated with the migration of the First Federal consumer portfolio which we can sort of box and see and look at and put our hands around and manage.

And just one other question. Should you fully reduce wholesale funding by $2 billion by the end of this year, would you expect additional investment security sales or what I'm trying to accomplish is come up with average earning assets for the year under that scenario, under the full $2 billion?

As investments mature we would use those funds or at least a portion of them to continue that phased deleveraging. And we've moved our investment portfolio down to about 17%, 18% of assets right now. And we need some level of investment assets for collateral and the like. There comes a point where you can't really go much further. But we're also hopeful that if we can continue the momentum around deposit growth and the like that we can use some of those dynamics as well.

I appreciate it, thank you.

And again, there's lots of moving parts. If you go back to the third quarter and look at borrowed funds it's not down in net terms, the billion dollars that I talked about because we brought a bank in in the middle of it. So there's lots of other things going on. But the activities that we're going to undertake we will get at that $2 million and then we will have to reconcile around some of the other movements.

Thanks.

Kevin Reevey from Ryan Beck.

Good afternoon, guys. How are you? Paul, earlier you mentioned that you expect credit spreads to improve on your commercial loans now. What I've been hearing from a lot of the banks that I follow is that credit spreads are narrowing. So can you give us some insight as to why you think credit spreads will improver versus narrow?

Sure. Well I'm not looking for a massive improvement but even an ebbing of deterioration would be a good thing too. Less real estate, more core C&I and more consumer and more small business. That mix is more attractive. And the other thing we're focusing our management attention on is the discipline around pricing, and we've talked about this and sometimes the talking and the doing are difficult to link together, especially in a competitive environment. And we are driving hard to make sure that we instill a sense of pricing discipline. And if we can -- on the size of our portfolio over time, 10 basis points is a very significant amount of money.

And what do you mean when you say pricing discipline?

In the minds of the lender, of the business banking relationship manager, how do we sell, how do we position, how do we underwrite, how do we negotiate to make sure that we are getting paid? And to set borrowee hurdles on those transactions that are managed with discipline, so that if we are going to compromise on the price of the loan, we're getting the full rich demand deposit and fee insurance and the like potential out of that relationship that warrants it.

So you can be competitive and you can price, but you've got to be making your money somewhere in this relationship, and you can do ROE calculations customer by customer, transaction by transaction. And frankly, we still have more work to do to make sure that gets burned in.

And earlier you talked about sales processes. Can you share with us your core sell product statistics if you have that available?

I don't have it sitting here in front of me, and it would be different consumer to commercial. Give us a little time; we can pull some stuff together for you.

Okay, great. Thank you.

Andrea Jao from Lehman Brothers.

Good afternoon. First question is on actually recovering deposits that you mentioned earlier; hoping to get a little more detail on the type of deposits that are coming back. Are they coming back as CDs? Will this affect your cost of funds, and do you think it is sustainable?

Yes. We've positioned a whole new set of demand deposit products out into the marketplace, packages focused on small businesses that provide a new set of products for both the transaction and the loan side. New -- I'll say new and improved because we've had indexed money market accounts for some time, but new consumer-base indexed money market accounts that really have been one of the big draws in terms of the interest-bearing deposit flows. And yes, in this environment on a relative basis, it slightly increases the overall cost of funds, but it allows you to get the banking relationship. And in this context if you're going to grow deposits, this is how you are going to do it, on the interest-bearing side.

I feel good about how our consumer demand deposits even in the first quarter where there was seasonal pressure have grown in real terms in the first quarter, and the momentum around the sale of these demand deposit products both in our traditional system but especially in our in-store banking system, and that was the design of that thing. It is early on in the game, but we like to see the numbers. And you've got to get the accounts before you get the balances.

Got you. Next question, could you give us a little more color on your (indiscernible) securities gains in coming quarters? Should it be the same run rate as in the past four quarters?

Well in this last quarter there was the $2 [million] gain associated with the execution of the sale of the investments and the purchase or the buy down of the wholesale fund. Last quarter there was a $2 million onetime gain that was associated with I believe the sale or an equity sale of the sale of the property. We've been in the $1.5 million $2.5 million range for a variety of reasons and there are things that are happening all the time. And then there may be some onetime things like the sale of servicing to sort of normalize the natural hedges that exist there for good business reason that appeared in the fourth quarter. But a couple of million dollars on our income statement in the quarter is a result of us giving back value to shareholders and we think we have an opportunity to do that. And the activities, the normal activities of the business.

Okay.

But I don't think they are significant at this point and I don't see them becoming a more major part of the earnings stream.

Okay, that is helpful. Any comments on the pace of repurchases for the remainder of a year?

Well we repurchased 4 million shares in the first quarter. We still have the authority to repurchase an additional 4 million and I think history has been that we have not been hesitant to use that when it is the best opportunity for a capital deployment. And we'll continue to evaluate those opportunities against the return on equity opportunities of the different loan categories that we are looking at, mortgages especially and that sort of thing. Would we rather put some of those loans on our book or would we rather buy back stock? We've been reasonably aggressive there and we will continue to view that as a very serious alternative for how we want to deploy our capital over time.

Great. Thank you.

Brad Ness from FBR.

On the margin, it seems like you guys are thinking the margin is going to bounce back in the second quarter to from kind of the fourth quarter levels. Does that also imply you think net interest income will be somewhat similar to the fourth quarter also?

It's certainly going to be better than it was, well certainly -- we anticipate that it's going to be better than it was in the first quarter and it's going to certainly approach back toward those kinds of numbers. I don't have that -- I could get the whole schedule out and take a look at it but -- approaching it certainly, yes.

Okay, and with the cost saves --

I'd be happy if it hit it.

That would probably be pretty strong. Have you achieved all the cost savings from State Financial?

Yes, absolutely.

So you did hit your goal as far as that goes?

Yes. And then some. I mean if you look at the run rate of staff expenses you can see how it compares. I mean it is actually down from the first quarter of last year after acquiring an entire bank.

A couple more here. With the securities that are kind of running off the books over the next year that hopefully it will be kind of a source of funds for paying down the debt, are any of those kind of caught underwater like some of the securities that you sold in the first quarter?

There may be a few but we've dealt with the lion's share of that to the execution of the transaction in the first quarter -- or in the first quarter. Then obviously if [books] move up another click or two, then that could change that. But remember our duration is pretty short. And we're hopeful that we can continue to work through that.

Last question here, it seems as though you typically have been giving a statement in the press releases such as we feel comfortable that we can meet '06 consensus. It seems like that kind of standard statement has softened a bit. Can you just comment on that?

I'd think that is fair. As I said at the end of my comments here there is risk in everything that I said. I guess it is up to you guys and the world to evaluate the risk versus the realities. It's up to us to execute. And that is our intention.

Great, appreciate it.

(OPERATOR Eric Grubelich from KBW.

Joe, this question is for you. On the first thing is on the securities portfolio rolloff can you just recap what -- where are you year to date or quarter to date on that? How much has actually been peeled off under this plan?

Let me try in general terms. What we said last fall is that we would get approximately $100 million per month. And that continues to happen and so therefore for this quarter we got about $300 million. So if we got plus the seven that we did as a onetime. And then we had approximately $250 million in the fourth quarter. So you can see we still have some runoff to go here as we are look into the rest of this year.

Okay. And then on that related to that the wholesale borrowings that you pay down from this, is it really -- are you really going according to the schedule of what those -- how those wholesale borrowings mature to take the securities off? Is that really driving what is making you sell the securities, that schedule or not?

No.

No, it's the investments.

Okay.

No, we are very short on the funding side. We can just pay it off when we get the cash.

Because I was looking at your balance sheet in the press release December to March and the big change in the borrowing was on it says longer-term funding. The short was kind of flat and the longer term was down. That is why I was asking the question. Is it a function of the maturity schedule on your advances as they roll off -- that's what you are using to pay down the securities? I mean vice versa.

It is -- that isn't the reason that -- a couple of things that are going on. There are just some two and three-year financings that are just coming in inside of a year. But, no, there is still again, you can look at the short-term borrowings and you can see there is plenty of money there for the deleveraging we're talking about here. That isn't the thought process. It is to simply the mechanics of when these things mature.

I'd got you. Thanks very much.

(OPERATOR INSTRUCTIONS) Sir, there appears to be no question.

Okay. Well then thank you all for participating. And if you have any other questions feel free to give Joe or I a call.

Thank you.

This concludes Associated Banc-Corp conference call. You may now disconnect and have a wonderful day.