Associated Banc-Corp (ASB) 2006 Q4 法說會逐字稿

At this time I would like to welcome everyone to the Associated Banc-Corp fourth quarter 2006 earnings conference call. (OPERATOR INSTRUCTIONS). It is now my pleasure to turn the floor over to your host, Paul Beideman, President and CEO. Sir, you may begin your conference.

Thanks, Eduardo, and thank you all for participating in our call today. We have several important issues that we'd like to discuss with you today. Obviously, I'll start off with earnings and our prospects for 2007, but I'd also like to spend a couple of minutes discussing with you our hiring of Lisa Binder as President and Chief Operating Officer of Associated, and our announcement yesterday of the acquisition of First National Bank of Hudson as well.

Everything that we've been doing in 2006 is focused on our strategic objectives, which you all know are to diversify our revenue streams, improve the quality and sustainability of earnings, and to keep investing in our core markets. And we think that we've made really excellent progress on a variety of these fronts in 2006 that are designed to reposition the franchise, and we look forward to seeing some of this progress really begin to pay off in our performance in 2007.

When you look at the quarter, we earned $0.57, compared to $0.58 in the third quarter and $0.64 a year ago. We highlighted in a press release several really substantive onetime items so that you can see the core comparison a little more clearly, and these substantive items really occurred both in the fourth quarter of '05 and in '06.

In the fourth quarter of '06 we had really two substantive items -- a $2.1 million loss on the sale of $300 million of one-to-four family residential mortgages, and a $1.8 million charge to staff expense for severance-related expenses. And the severance expenses relate to actions that we've taken to consolidate the management of our mortgage business regionally, and actions to support our commercial banking initiatives and add efficiency initiatives in the retail system.

First, let me just look at the balance sheet quickly for you. In the quarter, loans were essentially down slightly, but flat, and then flat for the year after adjusting for the mortgage sale. If you look at the components of it, C&I loans grew about 8% and consumer loans grew 7%, with a steady decline through the year in our mortgage portfolio, and commercial real estate being essentially flat. This is basically what we said we were going to do within our commercial portfolios this year. And these actions really are designed to protect us, to some extent, from the cyclical real estate risks that we've talked about before in this very challenging environment, but to focus our resources where we think we can get paid to create the right return on equity in the commercial business. And we'll talk about that some more in terms of the progress that we've made in our commercial banking initiative to reposition that business later.

On the deposit front, we continue to make good progress. Our deposits were up 5% in 2006 point-to-point, but were up 9% on an average balance basis through the year. And we grew demand deposits 10%, and money market deposits grew in excess of 40%, overcoming declines in core savings and NOW account categories, as we've seen some disintermediation certainly among those deposit categories, but also some core growth as well. And when you compare us to ourselves on a relative basis to prior years, those growth rates really are quite different, even in the challenging environment that we are.

We're very happy with our demand deposit growth rates, and you know that that's an important strategic priority for us, and we look forward to being able to maintain those rates and perhaps even improve upon them next year.

Our margin in the fourth quarter was 364, essentially flat to the third quarter. And very importantly, our loan-to-deposit ratio improved from 112 to 104. And we're making steady progress, we think, on improving the nature of our balance sheet and the characteristics of it.

Probably the most significant thing that we did in '06 was the repositioning of the balance sheet by reducing wholesale funding by $2 billion. And early in the year, we said we were going to attack that, and we've been very successful, I think, in implementing that initiative through the year. And you can see how it's improved our margin from where we were in the first quarter to where we are now at the end of the year. Certainly our deposit growth has also been much better than historically, and that has been a positive impact on our margins as well.

We continue to fight to maintain pricing discipline, both on the asset and the liability side of the equation out in the market. And we have seen some improved stability in terms of the migration and movement of loan rates and deposit yields. And we're seeing some good trends there as well, also contributing to the support of our margin.

We continue to show, I think, very good momentum in the core fee categories, the ones that are strategically important to our businesses -- Trust fees, service charges on deposits, retail commissions from our insurance businesses and our brokerage business, and debit and credit card fees. All of these categories were up every nicely in the fourth quarter and have been strong in terms of year-over-year comparisons as well. And we believe that because of some of the actions that we have taken, we're going to see good momentum and sustainability, and some of those increases going into '07 as well.

The mortgage component of fee income was significantly weaker in the fourth quarter and measurably weaker in 2006 as a whole. And that's a result, really, of the impact of a couple of key variables. First of all, in '05 there were some significant onetime positive comparisons in the fourth quarter relating to the sale of mortgage servicing rights. But also, when you look at it in terms of the entire year, there's been a measurable difference in terms of the impact of the valuation of mortgage servicing rights when comparing year-over-year, and the effectiveness of the execution of the sale of mortgages into the secondary market. We feel very, very good about our origination volume, which was essentially flat in the fourth quarter, which in the past has been seasonally down. And that bodes well for us, we think, going into 2007.

In the fourth quarter, the mortgage volume that you're seeing there has been adversely affected by the $2.1 million loss on the sale of the $300 million of mortgages, and a -$475,000 MSR valuation in the quarter. So, that's embedded in those mortgage numbers.

This sale of mortgages that we've made here, really, from my point of view, is the continuation of a process that we've been undertaking now for 18 months to continually prune the portfolio, if you will, and adjusting it to strengthen it and to minimize volatility. These one-to-four family loans that we bought -- that we sold had a yield on them of about 5.25%. And they were adjustable-rate loans. And our history has been, and, I think, most of the industry has been that these adjustable-rate loans as they approach maturity have actions taken against them so that they don't mature into the fixed-rate loans that they could become in the future. And we felt it was a good, solid decision, again, to adjust this mortgage portfolio continually so that it's strengthening its contribution to the organization and minimizing volatility.

Expenses, we think, were very well controlled in the quarter, coming in essentially flat to the third quarter and the fourth quarter of '05. I did want to note for you that the reduction in staff expense primarily reflects the impact of our adjusting the variable components of our compensation that are directly linked to performance and revenue expectations. We've taken steps to build our program so that they are linked to the expectations that we set for ourselves, and compensation will continue to be in the future variable, based upon how we're performing against our targets and our budgets, and directly relating to revenue growth. And that's really something that we're seeing there in the fourth quarter.

In terms of asset quality, our charge-offs in the fourth quarter were $3.2 million higher than in the third quarter. This increase is directly the result of one large C&I credit, where we took a charge for $3.4 million. Nonperforming loans increased by about $12 million, at 10%. And there's certainly always a lot of movement in this category of loans coming in and loans coming out. But the lion's share of the increase was one $8-plus million credit that we feel very good about in terms of our collateral and our security there, and don't really see or anticipate losses. So, those are really the two big dynamics that affected asset quality in the fourth quarter.

If I could now, let me take a minute and start to look forward into '07. And since I'm ending with asset quality in the quarter and in the year, why don't I start with that in terms of what we see.

We believe that our charge-offs in '07 will begin to normalize in a range around our historic averages. Losses in the fourth quarter were about 18 basis points -- again, largely driven by this one credit. But we feel that as we move through the year, we're going to see it slowly migrate back towards those normal types of ranges. And let me give you some flavor as to why we feel that way.

First of all, if you look at the Company historically, associated NPAs have always been higher than peer levels, while our losses historically have been lower than peers. And we believe that we're going to continue to see that kind of a trend. Why should our losses be lower than the peers when NPAs are at the levels that they are?

I think there's really three reasons for it. We underwrite well, and we are very, very well collateralized. So, when we have loans that become nonperforming, like this large one that I was just referring to, we feel very strongly collateralized, and the loans are well underwritten, so we think the loss prospects are small. We also have a history of being quite good, I think, at working out troubled credits. And we've been able to show that over a very long period of time. When I first arrived at the Company, you may remember, we had a tick-up in nonperforming loans, several large ones, at that time. And we've been working those loans for the last couple of years quite satisfactorily. And I feel comfortable that we have the capacity, especially when they've been underwritten well, to work them well.

But let's look at where we are now and forward. And I think we have taken several important steps that are going to mitigate risk in this environment. First of all, we have deemphasized home developers for some time. And really for the last 18 months we have been under-emphasizing those types of relationships. And the projects that we have done in the real estate arena have been focused on working with larger, well-established companies with which we have long-standing relationships.

Our consumer and our mortgage portfolios have been and continue to be stable, in terms of the migration of those loans, and we feel pretty good about that. 96% -- just a couple of important facts for you here. 96% of our real estate loans are directly originated by our people, and they're not participations. So, we know that we're applying our underwriting standards and our disciplines regarding the collateral of those loans deal by deal. 93 to 95% of those loans are in our direct banking footprint and not out of market.

One interesting statistic -- in the last four years, our corporate real estate department, that deals with really any companies of size, has had one charge-off of $1.4 million. So, over the last four years, this unit that manages billions of dollars of our commercial real estate relationships has had one charge-off of $1.4 million in the last four years. And we've had this unit overseeing our regional deals above $1 million in size for the last 12 months -- again, recognizing our focus on the cyclicality of the real estate business, and how we perceive the risk.

In our NPAs, there are 12 loans above $2 million in size, and none above 10 million. This $8 million loan that just became a nonperformer is the largest one. So, when you look at the dynamics and the composition of our nonperforming loan categories, we look at them, we feel well-collateralized, and we don't have individual relationships in that portfolio of such a size that are putting the Company at a level of significant risk.

So, I wanted to share with you some of those details regarding our view of credit and how we're managing it and some of the dynamics in a little more detail than normal maybe, so that you can get a flavor and then make your judgments as to how we are dealing with this environment, where we all agree that credit risk is going to be more challenging as we look forward.

In terms of some other variables, back to the balance sheet for a minute. I think we've shown good momentum in terms of deposit generation in 2006, and we'd like to think that those trends are going to continue into 2007 because of the initiatives that we're taking in our commercial and our retail businesses.

I would like to point out to you, and you'll hopefully please remember, that there are seasonal trends in these businesses, and certainly within Associated's balance sheet, and that we believe very confidently that in the first quarter we will see, again, our commercial demand deposits and municipal deposits decline. That will put some pressure on our margin and our net interest income in that quarter.

However, all of the initiatives that we've undertaken, especially to reposition the balance sheet and reduce wholesale funding, is designed and improved to mitigate those kinds of trends and to remove the volatility. Last year you'll recall our margin in the first quarter declined 16 basis points. This year, while there are so many variables that affect it, we see it in the 4 to 6 range. And that would be a significant improvement over last year. In any event, we think we've started to build the momentum within those important growth categories of deposits so that those trends will be improved in the first quarter and through the year.

I've been talking with you over the last six months and we've been working very hard to implement our initiative that focuses on improving the effectiveness of our commercial businesses, and we're well down that path towards implementation. We've segmented our customer base and our markets. We've reallocated our resources to those growth markets, with the exception of a few key hires that we want to make. And I expect to begin to see really tangible results from this initiative in the second half of the year. And tangible results, from my point of view, means improved deposit flows, but, more importantly, loan growth on our terms. We're going to continue to be disciplined pricers. We're going to continue to focus on the risks associated with commercial real estate. But through the positions that we're taking and the reallocation of resources that we're making here, we believe that we can start to generate the loan growth that we need to have to sustain a healthy banking franchise going forward, even in these challenging conditions, based upon the initiatives that we're laying out here.

Again, for some color, let me give you an example. In the Madison market in 2006, we generated over 180 new commercial relationships. 90% of them were C&I relationships, and C&I loans in that market grew 19%. The Madison market was not a legacy associated region. It didn't have a strong position in commercial real estate lending going in, and we've been able to bring our resources to bear in a different way in that market as a result of the distribution that we've been able to build up through the First Federal acquisition. Those are the kinds of results that we want to see across the rest of our footprint. Much of that volume was in the last six months of 2006. So, we feel that we can -- in the high potential markets like Minneapolis and Madison and Milwaukee, and the suburbs of Chicago, we think that we're going to be able to generate that kind of growth on our terms as we get these businesses repositioned.

In terms of fees, we anticipate mid-teen percent growth in fees next year in those key categories -- trust deposits, commissions and [cars]. And that's been our focus, it's been where we've invested our resources, and we've been generating, I think, some good momentum there.

We'll see very small increases in expenses year-over-year as we continue to manage those. Importantly, staff expense remains a variable expense. I think you'll ask me -- well, gee -- what's the run rate going to be? It's sort of an X and a Y axis. As revenue grows, then the compensation that supports the reward mechanisms with that growth increases. And I've talked to you already regarding credit. So basically, that's where we are spending our time, our strategic objectives are the same, and we think we've made some good progress that we need now to continue to build on and execute on to get our results to where we would like them to be in '07.

Let me shift gears, if I can, for a minute, and talk about the change that we announced to our management team earlier in the week. I'm really very excited that we've been able to higher Lisa Binder into the role of President and Chief Operating Officer at Associated. Lisa has managed a very large segment of retail and business banking operations for Citizens Bank, which is the United States arm of the World Bank of Scotland, in the Mid-Atlantic region and, more recently, out through the piece of the acquisition of Charter One to Chicago, Ohio, Indiana and Michigan. And she brings an incredible experience base to the organization that will really help strengthen our management team, and provide the capability to oversee the successful implementation of our strategy.

And really, that's a point I want to reinforce, that it's not about changing strategy; this is about enhancing our effectiveness at implementing the strategy. And I have had the opportunity to work with Lisa at Mellon for many years before her joining Citizens and my joining Associated, and I know that our organization is going to benefit greatly from having her on board. So, we feel very excited about that, and she's going to begin January 29th.

One other set of updates for you. We announced yesterday that we acquired the First National Bank of Hudson, and we feel good about that, too. It's a $400 million acquisition for us. But again, it's focused on building our capability in attractive markets. The area between Hudson and St. Paul in Minneapolis is one of the highest-growth areas, both in Wisconsin and in Minnesota. The median household income in the footprint for First National Bank of Hudson is $70,200, compared to a national average of $48,700. The population growth rate between 2000 and 2006 is 13.5%. It is a very high-growth area. The combination of what Associated has had within that footprint and what the First National Bank of Hudson brings gives us market share leadership in that little small, high-growth corridor of the world, and significantly enhances our distribution system in the region around Minneapolis and St. Paul. We feel that we're able to add to their strengths and their customer relationships with the broader product capabilities that we bring to the table, and we can create new revenue streams as a result.

We paid $93 million for the organization, which is 50% stock, 50% cash. So, the deal should be accretive to us at closing. And it's about 2.55 times book, and being a [sub-s] company by calculating our view of their earnings, it's about 18.5 times earnings. And there will be disclosures out on that in the next few days. We anticipate closing the transaction in the second quarter of 2007.

So, talked about an awful lot here. We will be -- Joe is here with me. We will be happy to answer any questions that you might have on any of these subjects, or any other subjects of interest to you. So, Eduardo, we can turn it over to questions now, if you'd like.

(OPERATOR INSTRUCTIONS). Scott Siefers, Sandler O'Neill.

Paul, I think you actually hit most of my questions in your prepared remarks. I was wondering perhaps, Joe, if you wouldn't mind chatting a bit about any additional runoff we might expect from the securities portfolio as we enter into 2007, or is that kind of piecemeal repositioning pretty much worked all the way through? And then, Paul, the second question I had was for you on, just looking for a little more color on the commercial initiatives. It sounds like you guys have some pretty good traction in a number of the growth markets that you've highlighted. I wonder how you think things are panning out in some of the more steady-as-she-goes markets, so to speak.

Sure, Scott. As you know, we had targeted a targeted level of securities, and we're pretty much at that level. So, I don't see much happening. Obviously, we'll have to look at where the investment opportunity is. With the flat yield curve it's a challenging environment. But there [isn't] a strategy to take it lower, I guess, is what I'm saying. We may -- we'll be trying to reinvest runoff, but not actually consciously trying to take it lower.

In regard to the commercial initiative, we're trying to accomplish a few things -- align the resources that we have against the segments where -- and the markets where the real growth potential is, and then do a couple of other things. And I'm glad you asked about this, because I didn't really touch on it. We're going to, on a systematic way, move all of the smaller commercial loans into the branch system, if you will, so they can be serviced there, freeing up significant capacity, really across the entire footprint of the organization. And in the other banking regions that I didn't mention there, we are basically freeing up those resources to be much more productive against the business opportunities in those markets as well. This is not in any way, shape or form saying that the other markets like Green Bay and Wausau and the Fox Valley aren't strategically important to this, but that we haven't really done the job we can do at mining the growth opportunities in those markets that I mentioned earlier. But by freeing up the resources in our traditional markets and our core markets, we still have the ability to improve the growth trajectory there, both in terms of deposits and C&I lending.

So, it's a combination of all of that, understanding the segments properly as to where the potential is, understanding where they are well enough within our footprint, getting the resources aligned, and then lastly, freeing up the productivity of the bankers to really get at the potential within the markets across the entire footprint.

And the other thing that comes out of it is more of an investment in the branch system to be able to drive the growth in the microbusinesses that are around those branches. By allocating these loans and deposit customers to the branch system, we create much more of a level of understanding and capability within that branch system over time, and increase their capability to support growth from new clients as well.

Ben Crabtree, Stifel Nicolaus.

Paul, I'd like to talk a little bit more about this whole reorientation of the C&I business. You've talked about that quite a bit lately, and I guess a couple of questions. One would be -- from an internal standpoint, are you pretty much done with it? I guess another way of saying that is are we kind of through the severance cost thing, or is there going to perhaps be a bit more of that?

We're pretty much through it. There might be a little bit more, but it's not going to be substantive. We still have some positions to hire in Minneapolis and other markets like that. We have a few key positions that we want to fill that are yet to be filled. So, we're still working through that. Goals have been set. People have their targets and all that sort of thing. We're continuing to enhance training programs. So, it's evolutionary. The calling efforts are really ramping up, which is good. But this doesn't turn on a dime, either.

I guess that was kind of my point. You've kind of spent your money, but the revenues, hopefully, will show up as we move through the year.

Right. And the good part about the spending the money part is that it's really a lot of reallocation of money; there's not a tremendous investment. From a systems point of view, from an infrastructure point of view, we've got all the capacity and the capability. We've got to get our resources aligned better, provide better support mechanisms to the field so that they can get the job done.

This is somewhat allied to that area of questioning, and that has to do with what you said about the reorientation, or the reset, if you will, the restructuring of the incentive plan. I guess the question is, you said you had -- it resulted in a significant drop in the compensation line. I'm wondering if that is kind of a reversal of previous accruals, or is the number in the fourth quarter a pretty real base from which to grow from here?

I would suggest that our anticipation is that it will revert back to a more normal level. It's hard for me to say exactly what that is, because you can go over your planned staff expense numbers if their revenue and fee performance levels are higher than you would anticipate them to be. So, it really is an X and Y axis kind of a thing. But I think that's what people want us to do, and link compensation to performance. But it makes it less predictable, doesn't it?

I would suggest that throughout '06, as we saw that we were going to be not as successful as we thought we would in terms of bonuses and long-term incentives and all those kinds of accruals, we've been reducing them as we went throughout this year. And so, this is just -- the fourth quarter is just a continuation of that same thing that's been going on in the second half of the year.

We're in a range of what we would see as a run rate -- a couple, $3 million max. It's not massive on a percentage basis to the numbers, but there could be a $2 million or $3 million up or down swing in a quarter.

But that 68 million did include the 1.8 of severance, so --

Correct.

Okay. I guess I'm trying to get back to kind of a base. I understand what you're saying about the variability of it. I guess that's it. Thank you.

Andrew Marquardt, Fox-Pitt Kelton.

Can you give a little more color on what -- the one C&I credit that went -- that was charged off this quarter?

Sure. Everybody signed off on it. Everybody thought it was a good deal. It was a transaction where the company had been in existence for a long period of time, and it was sold to a new management team. We felt good about it, and we made a mistake. Everybody in the organization looked at it and thought it was good, and it was a problem. So, I don't know what more I can say about it. We all thought it was a good credit. And as it turned out, at the end of the day it wasn't. I have to sort of be -- I have to maintain confidentiality about customer relationships and all of that, but -- we haven't had an incident in like eight quarters. We've been just sort of right there, with a small number of very predictable kinds of things. And this one -- this credit was an outlier.

And in your commentary about entering '07, you expect to begin to see the normalization of credit quality or net charge-offs back towards your range. Can you remind us what you think your normalized range is or should be for net charge-offs?

Well, if you look at us over a long period of time, we've been in the 18, 20, 22 basis point range. It's really difficult to predict where things are going to come out. We feel pretty good about what we have been doing to manage risk.

I'll tell you, we're looking at another credit that's of similar size to this one that could be an issue for us in the first quarter, not maybe in terms of that size a charge-off, but there is risk out there. And when there's stress on the economy, you see more credit issues surface through time. We think we've been very aggressive at managing as best we can the risks around real estate and what we have seen in terms of the deterioration of the housing industry. Today, there was some great economic issue -- information that was issued where housing starts were really quite strong in the fourth quarter. Are those going to be more vacant properties, or are they going to be the precursor of a demand -- of new demand for home purchases? We're trying to balance those risks by not being involved in the high-risk components of those cyclical components of the business.

That's helpful. And so, just so I understand, is it fair to assume that we should expect that losses should be closer to the fourth-quarter level than the first half or the first three quarters of '06?

We'd like to think that we'll see charge-offs in a range between those numbers. That's where we'd like to think we're going to be. But our normal -- your question was our normalized levels; our normalized levels are in the 18, 20 basis point range. And when you look at the economic conditions, when you look at what's going on in the banking industry, it would be very difficult for me to sit here and say that it's going to be like it was in '05 and the first half of '06. I don't think anybody thinks that.

Right. Okay. Thanks. Separately, forgive me if I missed it from your prepared remarks, but what's your expectation for net interest margin for next year, and also loan growth as well?

In terms of margin, again we've worked real hard this year at trying to strengthen the margin position, and it's been around the low 360s. Next year, if we get loan growth, clearly, loans aren't going on at those kinds of spreads. So, we think there will be some slight pressure, but not dramatic. And again, Paul has already alluded to the potential first quarter issue. But again, it really depends on how successful we're growing DDA. Because if we grow DDA, that will offset any pressure we get from growing loans. So, we're thinking it's going to be within a band here, a pretty narrow band, of where it is. So, that would be my advice for you on the margin.

I'll take the loan question, if you want. Again, you have to sort of carve us into the pieces. I would like to think that our C&I growth is going to be stronger than it's been this year, almost regardless of what the economic conditions are. I'm comparing us to us. And I think that because of the initiatives that we are undertaking here, I feel pretty good about our prospects and our ability to grow those loans at different levels.

We're continuing to be very circumspect around commercial real estate lending. And as long as we're seeing underwriting terms and pricing that is unacceptable to us, we're not going to match it, we're not going to play. Our construction lending this year still was pretty strong, and we think that can hold up and even be a little stronger, maybe. But the term aspects of commercial real estate lending, if the environments stays as it is, is going to continue to be challenging. And the returns on equity up against the prospects of risk in a cyclical business cause us to be a little more disciplined.

I'd like to think our ability to grow our consumer loans are going to be pretty strong. And we did pretty well this year in a more challenging environment, admittedly, and based upon what the environment will give us. Our residential mortgages are going to continue to run off. We've pretty much made the conscious decisions that very few if any mortgage loans are going to go on our portfolio, unless there's some unique customer need to do that. So, our history and the history of the industry has been these ARMs are very volatile, and I think you're making a mistake if you think to yourself that we are going to generate these ARMs at very low spreads, put them on our books and they'll reprice. The practice just isn't that case at all.

So, we'd like to see our commercial loans grow in the high single-digits, our home equity loans better than that. And when you put it all together, we should see some improved growth over this year.

Terry Mcevoy, Oppenheimer.

Just looking at the rate of decline in average earning assets, it's continued to decline this year. And I know Joe mentioned that the securities book, at least the size, is pretty stable now. And you're talking about some loan growth on the C&I and the consumer side. Should we expect to finally see some growth in average earning assets as we progress through '07?

Absolutely. That's the clear intent. And the mortgage sale is another contributor to reducing assets this year, but it doesn't affect our net interest income really at all. And you're right; we ran off a significant amount of the investment portfolios this year, and that's going to be stable as well. So, yes; the expectation should be a return to growing earning assets. And over time, that's where you have to be.

You were, obviously, active buying back stock last year. With the deal that was announced yesterday, does that prohibit you from being in the market until the deal closes?

No, not at all. The cash portion of the deal is a quarter or less of our cash contribution in capital. And we just finished an ASR, and I would anticipate that we will continue to look at those options in the early part of '07 as well.

One last question. On the deposit side, there was a large deposit relationship that came in in Q3, so I was pleased to see the continued growth in Q4. Could you just talk about that relationship? And remind me where again that was within the deposits, and then where the growth came from then. Or if growth -- there was grow even with those deposits possibly leaving.

Okay. If you'll remember, we had a large corporate relationship with the Company that was sold. And it turned into first a deposit, and then a very meaningful wealth management opportunity for the Company. And we've been really excited about how that's played out. This is just how it's supposed to work. And a meaningful portion of those deposits did move into our wealth management organization in a variety of different ways -- some personal, some institutional. It's just really exactly how I like to think your strategies are going to work in terms of one business feeding another.

Some of the growth that we see in the fourth quarter is seasonal. And it comes in the form of municipal deposits, and it comes in the form of commercial demand deposits. Then you see the reverse affect of that in the first quarter. And if you go back and look at us year over year over year, you'll see those trends.

So, the deposits you're talking about came in in the money market categories. And our municipal deposits come in -- some are in the money market categories, and some are in the interest-bearing demand or the NOW account categories. So, a portion of the demand deposit point-to-point lift that you see from third to fourth quarter, and a portion of the money market lift that you see overcoming that one big deposit, is seasonal. But a portion of it is improved core performance as well. It's hard for me to segregate those two things. But you can sort of see it when it normalizes out through the first quarter.

As you go back and look at historical trends, I would suggest that last year -- let me say it this way. I believe that the trends in '07 are going to be smoother because of the quality of the relationships that we have been putting on, and some of the growth trends. I'd like to think that they are. Where last year it was quite a large swing from the fourth quarter to the first quarter of '06. I'm hopeful that the trend is going to be slightly less than that this year.

(OPERATOR INSTRUCTIONS). Heather Wolf, Merrill Lynch.

I'm sorry if I missed this during your commentary, but did you indicate what type of loan the $8 million nonperforming --?

It's a real estate transaction. But again, we feel very well -- or very good about the collateral and the prospects with it.

And by real estate, you mean construction? Or do you mean some kind of other type of commercial real estate?

It's not a construction loan; it's a term transaction.

Okay. And then, based on your commentary, should I assume that you have not charged off any of that -- any of that loan? Do you think you're going to recover all of it, so none of the charge-offs are impacted by that loan that went into nonperforming status?

That's correct.

Okay. It looks like you guys are firmly building reserves now. Is that a trend that we should carry through to 2007?

For the last couple of years our charge-off levels have been -- our provision levels have been at charge-offs. On a percentage basis, our reserves have been fairly stable. But that's probably a result of the relative flatness of the trajectory of the loans. So, you're right; on a relative basis, our percentage of reserves is high, or above peers anyway. I think that's a good place to be right now. If the growth trajectory changes, then those percentages would probably change. And as asset quality -- as the reality of what is going to actually occur with the level of asset quality and nonperformers, it could move up or down. But I think on a relative basis, we're pretty well positioned.

Also on credit quality, it looks like your 90-day delinquency loans are also up, off of albeit a small base. Do you have any commentary there?

I can't talk about it precisely. I can have you talk to our chief credit officer. It is off a very small base.

Andrea Jao, Lehman Brothers.

Hoping to get a bit more color in terms of what you're seeing in deposit markets and customer preferences.

I think this year, certainly, customers were putting their deposits to use, and were really working hard at not borrowing money. The competitive environment is just incredible, because there's no place to go. The yield curve just keeps it -- keeps the ability to differentiate yourself almost to a point where it's nonexistent. So, you put all those things together, and you've got to be much more aggressive. Selling, marketing, being out on the street and fighting hard for your business is more and more important than it's ever been in the past. And that's one of the things about our repositioning of our sales force is that it's designed to improve our performance, by getting it targeted at the right markets and the right segments, and then, in a serious-minded way, just consistently implementing the value-added approach that we can bring to the table.

It's still feels like, though, loan growth will outpace deposit growth, no? And if so, you've already [run down borrowings] a lot over the course of 2006. It seems like you'll need to build that up again in support of loan growth if you're not -- if you can hold the securities book stable.

That's one possible outcome. I'm not so sure that I accept your premise. Let me say it this way, too. It depends on what kind of deposits that you're growing. A $1 of demand deposits is $10 of any other kind of deposits in this thing. And the impact on margin stability is exponentially driven by the quality of the deposits that you're growing. And I can't tell you how aggressively we're focusing on that. And if all you're doing is trying to grow interest-bearing deposits, you've got the same competitive problem that you have on the loan side; every customer wants the highest variable rate they can get for one day. So, the difference between that $100 million of money market deposits or municipal deposits and the $100 million of wholesale funds is very, very little. So, it all depends on the mix and the quality of what it is you're growing.

A follow-up question in managing capital. Can you remind us to what metrics you manage capital to, and how aggressive, or your propensity to do buybacks in 2007?

We don't really have a formula. Through a combination of deployment of capital, like we did with the Hudson deal, the buybacks, like we've done in 2006. And admittedly, the buybacks in 2006 -- I'll say exaggerated, but -- were significantly higher because of the effects of the wholesale funding initiative. But basically we returned 100% of earnings to shareholders.

We continue to use it as a weapon in an environment where it's difficult to generate the return on equity that you would want to get from the asset generation side of the equation. You can't do that forever. We are repositioning ourselves to grow our loans, but we won't hesitate to continue to buy back stock in 2007 where we believe it's the best use of capital. It's this issue around traditional, historical commercial real estate growth levels, versus a better use of that capital in this period of time.

For now, we're still looking at tangible equity. I know there's some things going out there where folks are starting to look at other capital ratios, and we're studying those. And we've been operating right around 6.5 in 2006. I would think that that would be a good place to think about it. We might even be able to go a little lower. So, again, it really depends on the growth of assets. It depends on what other opportunities come along. Clearly, we're going to be aggressive in managing our capital. It's just part of what we have to do in this tough banking environment.

Understood. Last question. I know the Board kind of looks at the long-term EPS growth rate of 10%, and clearly, it's a difficult environment to do that. Wondering what your thoughts are.

Well, let's see. How much time do you have? Let me try and crystallize my thoughts. Over the long run, over the intermediate run, you should be thinking about growing your earnings and your dividends back to shareholders at those kinds of rates on a sustainable basis. But you have to be realistic in terms of the environment in which you operate. And right now, that is a difficult challenge. How much of it is you and how much of it is the external factors? And you weigh those things as objectively as you can. And then, what are your prospects and what are your alternatives? And you've got to think about that kind of thing all the time. And we do as a board. We want to be shareholder-focused in our decisions and what we do, and we think about all of those options strategically all the time.

The one thing I have learned from past experience is if you make a decision that significantly starts to bet the organization on one set of external outcomes, just because they have been in place for a long period of time, that thing that will happen immediately thereafter is it will turn and go in the opposite direction. Because banking is a cyclical industry. And you've got to be thinking about how you're positioning yourself for the future, almost regardless of those types of external variables. But 10% right now, I mean, is a challenge.

Eric Grubelich, KBW.

Paul, just to clarify this loss rate -- earlier in your delivery, you had mentioned the 18 basis points, the charge-offs in the quarter. And I had jotted down that you thought that '07 would be stable and maybe migrate back to more of a historic range, which would be lower. But when you were talking about the 18 to 22 in the follow-up Q&A, that's not lower than the 18 for the fourth quarter.

I'm sorry. Let me clarify what I was trying to say. I was trying to say that in '05 and much of '06, the levels of losses were extremely low. And in this environment going forward, we believe that they are going to start to normalize back towards the slightly higher levels that a longer view of history would imply. So, it's sort of the opposite of that. And I apologize if I twisted it up.

That's alright. The other question I had, you talked a lot about the deposit trends, the DDA trends. I don't get a sense that -- maybe it's the way you talk about it, but are you getting much growth from the retail side of the bank in the core deposits? Or is it pretty much coming from the commercial customer?

I'm glad you asked that question, because we -- the commercial area is getting so much focus because we believe that, on a relative basis, that's where the biggest potential to change the trajectory would be. We're seeing pretty good progress in terms of our retail initiatives. Our in-store system is generating decent levels of returns. Our net checking accounts for 2006 were up every month in the retail system.

That's new ones (multiple speakers)

New versus loss. And again, that trend is different for Associated Banc, too.

That was up every month in '06?

Let me go back and confirm that. I'm questioning whether there was one month where it wasn't. That's okay. Let's say it's 11 out of 12.

We'll give you that one, yes.

I'll take 11 out of 12. I just want to be precise. But, we're seeing good trajectory there. And it's a function of sustained effort at increasing and enhancing our sales process. We've put new products into place. We've changed our incentive programs, training programs -- a whole series of things. And that just keeps chugging along. I'm not highlighting it and I'm not focusing on it maybe as much as I should, because it's working okay. And the biggest change, if you will, is around what we're trying to do on the commercial side of things. So, I guess I'm highlighting that because it's where the biggest area of emphasis is, and where management is focusing its attention.

The comment that you made about pushing some of the commercial loan management servicing back out to the branch, what ballpark range credit are you talking about that's going to be pushed back out to the branch level for servicing?

Below 500,000 in size. Really small stuff.

So, this is a small business? Okay. And are those -- is there -- how's the right way to say this? If you have a centralized servicing platform to take care of those loans, if you put it back out to the branch, what has to change in terms of the capacity or the skill set, maybe, is a better way to say it, of the people in those branches to do that?

First of all, we have the full capacity of the central underwriting that can support that part of the transaction. We have x number of branch managers in the system that are very experienced and capable. And again, if you look at it in terms of where the potential is and where the customers are, you can put your hands on 50 branches that have 80% of the business and 80% of the potential. So, you don't have to go out and start training hundreds of people. You can focus on where those high-potential locations are, where the customers are. And you can use PDOs; you can transfer people from the current commercial business operation to help provide direct support.

The other point is a large number of the relationships that we're talking about here are deposit-only, and the branches are servicing the deposit side of the relationship for all these customers. So, there shouldn't be a big conceptual [leave] or a big risk factor involved in formally migrating all the aspects of the relationship to where a core component of it is being managed. The risk would be in loan-only relationships.

I would also maybe make a point of clarification. When we talk about this small business initiative, again, it's centrally underwritten, as Paul has already said. You have a call center for people to call in. But what used to be happening, and what we're trying to change, is a commercial lender would be spending time servicing that loan just as he would -- he or she would do a larger loan, and we're trying to be more efficient. The branch manager will be -- or a small-business person will be doing that management of the customer contacts and the sales and service (multiple speakers)

The underwriting is still going to be centralized on it. That hasn't changed; it's just the after-the-fact servicing of the customer.

And you get more throughput for the same staffing levels out in the field, and you free up your commercial lenders to call on different customer segments.

This is not a new concept by any stretch of the imagination. We have been -- we have, again, through our regional heritage, we have -- I have allowed this to be a grey area, where we can -- where we can use our discretion and keep those loans under the more traditional system (indiscernible). When you go in and look at it objectively, we've got to get it moved. What we're doing in terms of the profitability of that loan relationship, servicing it in any way other than this very automated, efficient use of your fixed-cost branch system, is just unprofitable. You shouldn't do it.

Okay. Joe, on the -- those mortgage loans that you sold, that $2.1 million mark, was that solely or purely an interest rate-related mark?

Yes.

It was rate only. I think Paul made the comment that, on the residential portfolio, notwithstanding this onetime sale -- or maybe not a onetime sale, but the sale in the quarter -- that this portfolio is probably going to continue to dwindle. What would you say is the burn-off rate we should be looking at there for '07?

Well, I would think that if you take the -- what it's been doing these last four quarters, I think that's what you should expect. (multiple speakers) take out the 300 million that happened this quarter. But look at it; it's been going down every quarter, and that's basically the burn-off rate.

So, there was nothing (multiple speakers)

There is very little production, because the spreads are just not there. And to use our funding and our capital, we're just not thinking that's the right thing to do.

If rates were to start down, the dynamics in that portfolio would change -- and not just ours, but lots of people's -- would change substantively.

And we're trying very hard to widen the spreads on anything we wouldn't need to put on our balance sheet that, in fact, we get paid for using our balance sheet. That's the thought process.

Marsella Martino, KeyBanc Capital markets.

I was just -- Paul, you talked about putting up some nice growth numbers in some of these fee income line items in 2007, your expectation that you will. I was wondering if you could just give a little bit more color on maybe a few of those, and specifically, if there was charges on deposits. Are you going to do anything different there than you have in '06? And also, maybe, if you can touch on, like, credit card fees.

Let's see. First all, our asset under management businesses are growing very nicely, both in terms of those assets, the market certainly has been a lift, and our selling efforts have really improved. Service charges on deposits are a function of a whole variety of things. One is opening a lot more checking accounts. That becomes a big factor there. And we've made a few changes from a processing point of view that have changed the trajectory there, and that have been able to really hold up in those categories where -- you haven't seen the disintermediation, if you will, on the net interest income side because of a loss of accounts. We think we've been able to balance that pretty well.

A great example in retail commissions -- first of all, our insurance businesses continue to perform very, very well. The synergies between our health -- employee benefits consulting business and our commercial businesses continue to strengthen. Our annuity sales this year are up 46% over last year. And, you know, that's a big contributor. So, we've set a new level for ourselves going into next year that's 50% higher than it was this year.

But retail systems' selling effectiveness continues to improve, and our brokerage business is generating the kinds of returns that we've been talking about over the last couple years. They continue to do a rock solid, double-digit percentage increase in fee income. And they're a top-decile performer when you look at brokerage businesses in terms of revenue per broker.

Our debit -- the card piece of it is really more debit than credit, and it's a function again of more checking accounts, a much -- our marketing initiatives, focused on generating much more card penetration and card usage. And those initiatives are paying off. So, when you put all that together, you can see over time how it's passing through those line items and permanently changing the run rates.

You get seasonality. The fourth quarter in some of these categories, card usage and the like, is much higher than it will be in the first quarter. So, some of them will come down. But then, the insurance business is much stronger in the first quarter than it is in the fourth quarter, and it will be much higher. So, these things will balance themselves out. But if you look at it over any period of time, you can see how the run rates, really in all these categories, are improving. And that's the people, and the business is managing it well.

Okay, great. That's some good color. Thanks.

(OPERATOR INSTRUCTIONS). Andrew Marquardt, Fox-Pitt Kelton.

Just another question I had for you guys. On the M&A environment for you guys, can you give us a little color on what you're seeing these days, as far as expectations changed at all over the last three to six months? And what's your appetite like in this environment, now that -- after the announced deal the other day?

First of all, we like the characteristics of this transaction a lot. It is a well-run company in a very high growth area with really top-notch people and great relationships. And it's really -- it's small in terms of its impact on us overall initially, but we think it's going to create a lot of revenue possibilities for us as we just get -- continue to see the growth in that market, think about branching alternatives there, and add a broader product capability. So, those are the kinds of things we want to do.

The First Federal deal we did was $4 billion. We're willing to look at larger transactions if they have the characteristics that are going to help us, right back to the strategic priorities I was talking about before. And really more than anything, it's about markets, and are we strengthening our franchise? Our franchise is much stronger than it was four years ago, I think, in terms of the acquisitions that we've done. And we're starting to see some benefits from that, like the Madison example that I talked to you about before. So, that's the kind of thing we're going to try and keep doing.

The environment -- perhaps we're starting to see some increased level of price expectation come back into the market -- some, but not -- really, it's not really changing the dynamics of the thing significantly. It's -- we're seeing tons of opportunities and very few deals getting done, and that's the reality of why. The price expectations versus the reality of what we're willing to do are still very, very different.

There appear to be no further questions at this time. I will now turn the floor back to Paul Beideman for any closing comments.

I have no closing comments at all. Thank you very much for your participation and your questions. If you have anything further, please don't hesitate to give Joe or I a call. Thank you, all.

Thank you. This concludes today's Associated Banc-Corp fourth quarter 2006 earnings conference call. You may now disconnect your lines, and have a wonderful day.