Associated Banc-Corp (ASB) 2007 Q3 法說會逐字稿

Good afternoon. My name is Esia, and I will be your conference operator today. At this time, I would like to welcome everyone to the Associated Banc-Corp third quarter earnings 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 Beidman, Chairman and CEO of Associated Banc-Corp. Sir, you may begin your conference.

Thank you very much and thank you all for participating in our call today. Lisa Binder and Joe Selner are also here on the phone. As you saw we announced earnings of $0.56 a share here in the third quarter. As is normal I'll try and make a few brief comments about some key components of it, then we'll be happy to answer any questions that you have. Why don't I start with the margin. We're really very happy with the fact that the margins and net interest income improved really measurably in the third quarter, up to 3.62 and net interest income up over $5 million over the second quarter. In essence, everything that was weak about the second quarter returned to normal levels, and in the third quarter as it relates to levels of prepayment fees and non accruals, which you'll recall we were identifying weaknesses in the second quarter, and those things got back to normal levels.

But I think most importantly, and as simply stated, loan yields improved while deposit costs stabilized, and that takes a lot of work, but it's what we have seen in the numbers. Our home equity growth was really quite solid in the third quarter, and that's something that we've been emphasizing and focusing on. We've talked about that possibility of occurring here in the second half of the year. Really glad to see the lift that we're generating. That is our highest yielding asset. But really with market movements that are beginning to occur here, pricing I think really becomes the biggest variable, and we're seeing our loan spread beginning to improve through September and frankly continuing to October, and we believe that as interest rates move here there's an opportunity to -- and as credit markets stabilize, we believe that increased spreads are a real opportunity for us. One aspect that was somewhat unique to the third quarter was the dislocation around LIBOR rates as a result of those market conditions that existed in August and September. And that had a positive effect in the third quarter which obviously won't really continue going forward. On the liability side, we believe that we have continued to be fairly disciplined in terms of our money market and our CD pricing, and we've talked about this before. We try to take a portfolio approach to managing costs on the deposit side of the equation, and we don't take the lead, but we can have pieces of our money market and certificate portfolios out there with very competitive rates while we're working to manage margins for the portfolio. Also, average DDA balances were higher in the third quarter which is a contributor. But when you put it all together, asset yields are up 6 basis points while our liability costs were down 4. And that is probably the single biggest factor in terms of driving the margin improvement.

Much of the effect of the interest rate changes really wasn't felt in the third quarter since those changes occurred late in September. And that we -- when you put all this together, we anticipate that the overall level of net interest income will be essentially the same in the fourth quarter as it was in the third quarter. We'll continue to see strong home equity growth. We'll see DDA seasonality as a positive, as well as some core momentum in DDA growth that we've been focusing on, and we'd like to begin to see some improved level of commercial loan growth as well. And when you put it all together, the one-time effect, basically, of the LIBOR positive effect of LIBOR dislocation in the quarter in the third quarter, can be more than offset by the core variables around spread on commercial loans, growth in home equity loans, and positive flow on the deposit side of the equation. So we believe that the overall performance in terms of margin will be stable going forward. And opportunity as -- if margins can be maintained and pricing can improve that performance and core growth can improve that slightly.

In terms of credit, you can see where our charge-offs were in our provision. The charge-offs in the third quarter included $6 million loss basically from one credit that we've been talking about frankly from the earnings announcement from last quarter. And we've said that it's a possibility, and that did occur. We became aware of the risk associated with this credit really right on top of our earnings announcements last year, or last quarter. And have been talking about it with as much clarity as we can ever since. But as a result of that, really the credit was not a nonperforming loan at the end of the second quarter. So it was something that we've been carrying with us and working through this quarter. So C&I credit, there it is. It's something that we view really as an isolated incident due to the nature of it.

If you put this credit aside we really feel quite good about the overall direction of our credit matrix in this very, very challenging environment. We're really beginning to see coming to fruition some of the efforts that we've been putting forth to really attack the level of commercial nonperforming loans, and certainly that's paid off. Commercial nonperformers are down over 20% or about 29 million. And while it's harder for you to see, our sub standard loans are also down about 50 million. We are going to continue to focus aggressively on reducing these loans to choke off the flow of loans into the nonperforming category. There's no doubt that this puts some pressure on our volume optics, but there's also no doubt that it has a positive impact on performance going forward. And helps us manage risk in this challenging environment.

I don't think that we'll see the same level of reduction in the fourth quarter that we've seen in the third quarter, but we would certainly like to see those levels of nonperformers at least stable, and hopefully with some additional reduction going forward. It's also important to note that through the nine months this year our consumer charge-offs remain stable to '06 levels, and our consumer foreclosures remain stable to '06 levels as well. And I believe that that's really a function of how we've been focusing on managing our core mortgage business but also how we've been changing the variables associated with how we're managing the risks associated around mortgage and home equity credit. Our provision in the quarter was 8.7 million, leaving us with a reserve percentage of 1.32% of total loans, and this is well within our ranges to determine adequacy. And so we feel that that was the right action to take here at the end of the quarter.

Fees. Core fees are continuing really to show quite strong growth year-over-year and frankly quarter-over-quarter. And I've said this before. My clearest comparison is year-over-year for the efforts of the organization. Our trust fees are up 16%. Deposit fees are up 14%. Commissions are up 8%, even though the insurance business has sort of been flat, but our brokerage business has really been a very strong performer in that category as well, and our card based fees are up 19%. So we feel very, very good about that growth, and believe that we have the momentum in our businesses to continue to generate that kind of growth. The mortgage business was down slightly. The biggest effect there was the valuation change from the second quarter of $4 million in regards to the MSR asset, and there's a reduction in one-time fee gains of about $4 million. Expenses are up about a million and a half. That's entirely a result of having Hudson in the system for three months instead of one. And you can see that our staff expenses are virtually flat, so we feel that we've done a pretty good job of integrating the company but also getting the saves out of it that we had anticipated.

Just briefly about the fourth quarter, and just some facts there. Really, I think maybe the clearest way to think about it is what's repeatable, given the fact there are some really substantive changes I think in terms of very important aspects of our performance here in the third quarter. Margin and net interest income in the third quarter were very, very strong, and up very noticeably from the second quarter. We believe that much of this momentum will continue and as a result of all the variables that can affect this complex equation, we believe that the overall level of net interest income in the fourth quarter will be at roughly the same level as in the third quarter. And that if there were any one-time things in the third quarter, they're going to be replaced by the core variables and the core movement around pricing and volume in the fourth quarter. In terms of fees, we believe that the core fees will remain strong, and that mortgage bank willing be relatively stable. So the growth that we're seeing in core fees is sustainable, and hopefully the 4% -- or the $4 million deterioration in MSR evaluation isn't repeatable but the level of performance in the mortgage business we think is.

In terms of credit, we have stated and in the quote here in the news release, we believe that our losses will settle at historic levels for the company, so that is basically saying that we believe that the level of provision that we've taken in the third quarter perhaps even better than that, based upon what we're looking at, within a range is repeatable again in the fourth quarter as are the level of expenses. So, in a nutshell, that's the quarter. We feel very, very good about the progress that we're making around the variables that we control. And that's really what we're thinking about in terms of how we're managing the business in this environment. It is an incredibly challenging environment, and as the economy goes, so go we and the rest of the financial institutions in it. But we're fighting very hard to manage the variables that we control, to maximize performance around net interest income creation and managing the risks associated with credit in this environment. And we'd like to think that the progress that we've made here in the third quarter is going to be sustainable.

So, those are my comments, and I'd be happy to open things up for questions. Oh, I'm sorry, one other quick thing. In relation to the fourth quarter, there probably is going to be some noise created as a result of these branch sales that we've been talking about. We had a small amount, less than $2 million, in terms of financial gain in the third quarter, but in the fourth quarter we're going to see between $12 and $15 million of premium from the sale of branches and deposits will be impacted. They were adversely impacted by about $50 million in the third quarter, maybe a little less, and will be impacted by about $180 million in the fourth quarter. So there will be noise there. But we also -- our intention is to not just pass this $12 to $15 million worth of gain to the bottom line but to investigate some actions that we may be able to take in the fourth quarter to put that money to use to enhance our performance going forward. So as we clarify our plans in that arena, and it's appropriate to do, so we can provide more detail. But that income is very likely going to come in in the fourth quarter, and we will take a series of actions, perhaps creating severance accruals or doing some restructuring to put that money to good use so that it's not just going to pass to the bottom line. So now we can open things up for questions.

Thank you. (OPERATOR INSTRUCTIONS) . We'll pause for just a moment to compile the Q&A roster. Your first question is coming from Andrea Jao with Lehman. Please go ahead.

Good afternoon, everyone.

Hi, Andrea.

Just want to clarify what ex acquisitions, balance sheet, loan growth, deposit growth was and the contribution of the acquisition to the margin this quarter.

Of Hudson?

Yes.

Well, it's really quite small. The entire asset size of the thing, in terms of the loans, was under 300 million. So it really is very small in terms of its impact. It had some small effect on average balances, but, I mean, it's really pretty small. In terms of net deposit levels, the sale of the branches and reducing them by $50 million probably had a bigger effect than Hudson did.

Okay. Just checking. And on the margin, similarly modest?

Well, on a $22 billion thing, 300 million of assets spread across the categories about equally isn't going to have much of an effect.

Now, in your press release you stated that real estate construction loans added to loan growth. Isn't that a bit surprising?

I'm sorry? Isn't --

Wouldn't growth in construction be a bit surprising at this point?

Well, we've been -- no, I don't think so. There's a couple of things going on. One is that the conduit activity really isn't anywhere near where it used to be, and so the pay offs, which were affecting all of our real-estate portfolios, are at a much lower low. In fact, almost nonexistent in the third quarter. And the construction lending that we continue to do is focused on our large customers, driven by our corporate real-estate area with -- in which we have really significant confidence on financial terms with which we're comfortable, and we've been spending really a lot of time focusing on the segments where you can play, and in retail construction, and in apartment building type construction, those are areas where we're still seeing good growth -- I mean, condominiums, no. But almost, as a counter balance to the housing market, and the condominium-type real estate development, apartments actually are strengthening their position because customers are moving toward that as an alternative. And we have seen, especially in our metro markets, that that type of construction, with well established customers who we know who have diversified risk, is pretty stable.

Okay. Great. Thank you.

Thank you. Your next question is coming from Scott Siefers with Sandler O'Neill. Please go ahead.

Good afternoon, guys.

Hi, Scott.

Just had a couple of separate questions. Paul, I was hoping you could kind of drill down into the pricing environment a little more on the loan side. You made some of those comments in your margin discussion, but I guess I'm wondering where that improvement is coming from, if it's customers willing to tolerate higher rates, or you guys drawing the line in the sand, et cetera.

Well, we've pretty much had the line in the sand for sometime. The difference is, maybe the world is rationalizing a little bit, and the folks -- the companies that have been more aggressive in the past are being more circumspect. The fact that they're at least has been the development of somewhat of a curve allows for that. When interest rates come down, historically credit spreads improve. And if you go back to historically and look at it, we've seen it, and if we can be disciplined enough, we can capture it. And so far we've been pretty successful at it. Also, the growth in home equity is, if that's sustainable, which we believe it is, even in this environment, if we're doing it to our credit standards, with our customers, you know, that's a yielding asset that is, on a relative basis, creates a stronger earning stable asset on our books. So all those things together start to balance it. Then if you can control pricing on the deposit side and be disciplined as rates are coming down, then, you really are locking that in. So it's working both sides of the equations, but the bankers in the system to have realize what the opportunity is when rates change, and focus very precisely transaction by transaction on how they're going to capture it. So it's really a meat and potatoes approach to selling and knowing what it is that you're trying to do before you talk to the customer. It's a different environment now than it was two or three months ago in terms of that opportunity.

Okay. And then on the home equity, I wanted to kind of follow-up on that as well. That's all just your own customer base. You're not doing a bunch of correspondent or brokered stuff?

Virtually all. A company our size is a little bit of everything in there, but it's virtually our customer base. A function of better marketing and better selling.

If I could jump over to credit for a second I wanted to follow up. I thought there were a couple of credits that you had -- that you guys had specified on the second quarter call and one of them, obviously, you talked about. Was that other one that could have been involved in a charge-off, has that been removed now?

It's hard to remember three months ago what I was thinking about, but I believe -- yes, I would say yes.

Okay. Sounds good. I guess I think you answered all the other kind of credit ones in your comments. So good. I appreciate it.

Sure.

Once again that is star 1 to pose a question. Your next question is coming from Terry McEvoy with Oppenheimer. Please go ahead.

Hi, Terry.

Hi, good afternoon. How much of the $27 million reduction in MPAs came from the sale of nonperformers in the quarter and could you comment on that market, please?

Yes. None. Well, it depends on what you mean by sale, I guess, and that's not a complex definition. But some companies package nonperformers together, go to a third party, sell them at a loss, who are disposing of them to another company. There's none of that in there. These credits have been work out. I mentioned there were a couple credits that we were -- I think I probably used the term selling, but it's almost -- it's being paid off, in essence, as opposed to selling it, to another provider of credit at PAR. So there's really -- and that's us working, that's our efforts going out there and finding someone to take the credit away. So the pay I don't haves, the nonperformers are a reduction or a result of being paid off, working the credit out, or having it go someplace else. We haven't packaged any loans to sell. That market right now is much tougher than it was I think for obvious reasons a couple of quarters ago. We look at it all the time. In my time here, we've never done it. But we continue to look although it, as an alternative, and if it's financially viable, we would consider it. But we've been able to reduce them and the substandard credits as well by -- and it just didn't happen in this quarter. We've been working although this for sometime, and there's a lot of flow in and out of these categories. We've been able to catch up and pass it by, if will you, so that we've gotten more worked out than were coming in. But it's a function of our credit organization and our bankers in the field focusing on it more and more aggressively and having it stick.

The charge-offs about $6 million ahead of the provision. Is that the $6 million credit that you've been talking about, or were other loans charged off that previously a reserve had been set aside?

No, it basically reflects that credit.

okay. Then just the last question on capital. It's up from the second quarter with the acquisition a couple quarters behind you now. Could you just talk about comfort levels for capital and potential uses of excess capital in the remainder of the year?

Well, our approach to that really is unchanged. We'll continue to balance, all the different uses, and we're not hesitant to buy stock back. If you'll remember, we had a buyback very, very late in the second quarter, with Hudson in that quarter as well. You could almost think of that buyback late, late in the second quarter as the third quarter event. But it happened to occur in the second quarter. But we'll continue to look at that as a viable option in terms of the use of capital, but we'll also look at acquisitions and at the dividend level each year. So our approach to it really hasn't changed much, but in the calendar third quarter we didn't buy back any stock.

Your next question is coming from Michael Cohen with Synovia Capital.

Could you talk about your appetite for acquisitions, and as well you had mentioned in potential restructuring charge in the fourth quarter to potentially sort of to improve efficiency. Where do you think you could potentially take your efficiency ratio to over time, given all the improvement you've had in other areas over the past three years?

Well, it stays in the low 50s right now, and we're pretty comfortable with the efficiency ratio in that area. Having said that, we continue to look at our expenses all the time, and also look at investments. So we're -- I'm not suggesting that we wanted to take our expense levels down significantly, but when we keep thinking about how we want to reposition ourselves and strengthen our ability to grow, you know, that implies maybe to some -- in some way dis-investing in business A, B, OC, and investing in another one, and those kind of charges would be necessary to do. That in terms of our acquisitions, we -- in this environment, things, again, having changed pretty dramatically, I think, and it may constrain acquisition alternatives, at least for a time here with buyers and sellers stock prices being somewhat depressed. We will continue to look at markets, really, as the primary driver, and will the acquisition generate a greater probability of growing incremental revenue and value as a result of it. So is it an attractive place to be, and does the company have the right culture and can we bring a business mix to the that can generate more revenue than it was generating for itself. So that's how we continue to think about it. We look all the time. We get opportunities on a regular basis. So if we were to find opportunities at the right price that would meet those criteria, we would continue to look to do bank acquisitions.

Do you generally kind of look at tangible book value earn-back periods? Is that one of the metrics you use, or how do you think about it?

Return on cash investment we think is an important variable. Certainly return on equity is a critically important variable, but a disciplined risk/reward analysis around what the possibility of gaining and losing revenue streams are going to be as a result of the mix of the company and the type of business that it does. You can -- and we've seen is it hundreds of times. Not with us, but where revenue expectations are grossly overstated in terms of what can happen in an acquisition. And you've got to really be able to understand what the risks associated with it it are, too. So, I mean, if you damage the revenue stream, your assumptions don't matter. It's got to be an objective evaluation of what kind of prospect are things going to create. Cash return really, I think, helps try and clarify that kind of thinking. Accretion or nonaccretion is a theoretical discussion, to a large extent.

Sure. Great. Thank you very much, Paul.

Once again, to pose a question, please press star 1 on your telephone keypad at this time. Your next question is coming from Ben Crabtree with Stifel Nicolaus.

I need a little help in understanding kind of the dynamics in the credit quality side. If I understand correctly, well, first of all, the $6 million charge-off is there more remaining of that loan in the books?

No.

So that's gone. But that was not included in nonperforming loans at the end of the second quarter?

Correct.

So in other words, the drop from 180 to 150 in round terms it happened completely irrespective of this loan?

Correct.

Okay. Just needed to understand that. And I guess that's basically my question. Okay, thank you.

Sure.

Your next question is coming from Kenneth James with Robert W. Baird. Please go ahead.

Good afternoon.

Good afternoon.

Just want to ask you a question about of your commercial lending initiatives. I know you put a lot of emphasis there and have been staking a lot of your expectation for better performance on generating CNI momentum, getting the corresponding DDA accounts. Didn't seem like there's been a lot of momentum. If you could touch on what transpired there and how if any of that might change here over the coming quarters.

We continue to work at it but we're working at it in a challenging environment, partially. Demand is an issue to consider. Our own constraints around credit quality and pricing and the like sometimes are a constraint, but we're continuing to work through those issues internally and to get our commercial business positioned well to start to generate that growth on our terms. In a very challenging environment. We to some extent are in our own way as we attack these substandard and nonperforming loans. I can sit here and say that our origination volumes have been improving, and to some extent that's true. Not quite to the level we'd like to see them, but part of the pay downs of these non-performing loans and substandard loans are substantive enough to weigh that down. At the end of the day, that's a good trade, and we're happy with it. And the optics of it aren't as positive as we'd like to see them in terms of the strategy in our commercial business, but it's the right thing over the long run for the performance of the company, especially in this environment. So, I'm not as happy as I could be in terms of where that thing is going and how it has been moving, but I feel good about our prospects going forward when I look and see what the managers of the business are doing. Our corporate business is really starting to grab hold. The conduits are to a large extent out of the way, so there's been a tremendous amount of noise in our real estate business around what we're doing versus what we were unwilling to do to match in terms of low ROE kinds of permanent financing and that's changing the dynamics a little bit to Andrea's question before. And we're see going solid growth in our home equity portfolio. So I get confidence that the management of the organization, that Lisa and her new team and the things that they're doing can get the growth. The last piece for us is to continue to work on this commercial segment to get it to the level that we would like it to be.

Okay. Thanks. And I just want to get a clarification on customer commentary on net interest income and margin. It sounds like in the way you're alluding to the would happen is the margin might be down a few bips, and burning asset volumes would be a little bit better to keep kind of the net interest income number flat. Is that a good assumption?

That's pretty much what I was trying to say. There's so many moving parts, you tell me if -- next week what the Fed is going to do. There's so many things that can affect this. But when we look at what's going on, that was really -- and the last piece is DDA. In fact, it's the most important piece, in terms of dollar for dollar, or how both the margin and the net interest income number move. But your summary was probably better than mine.

Okay. And if we get another 25-basis-point reduction this month does that change your thinking at all?

In terms of our asset liability management, we try to position ourselves to be neutral. But when rates move like that you get the opportunity to manage your spread differently, demand changes in the minds of the customer, and it's how well you executing against those things that really will then begin to move the net interest income. The spread opportunities when rates come down, if the curve comes into place, are real, and you've got to know that and be able to figure out how to position your business to capture it. So -- so why are we growing home equity loans right now in an environment where demand is down. Well, all things aren't equal. We're improving our selling and our marketing and it's bringing that business to the table and we' able to grow it. So that's a good thing. On the commercial side you have got to be able to recognize what the variables are and work on what you can control.

Okay. Just from kind of a -- I know better pricing spreads and some yield curves coming back are all good things, but just from a static GAAP basis it would seem like 75 basis over a 90 to 180 day period would be a lot deal on the loan side. Just wondering if you could comment on what you're seeing already with the 50 basis points on the deposit side, on the stickiness of rates. Are you seeing people aggressively take advantage of that, or are the deposit rates a little stickier than you would have thought?

It's all over the map. The smaller banks are out there trying to bang away on volume and price on both sides of the equation, and I guess they always do that, because that's all they can do. But we look at it, and we are going to -- we're going to work hard to be disciplined, and try and figure out what the answer is, and then manage the business toward getting that answer. You can still be competitive, but you don't lead. And that's pretty much our philosophy. If that constrains growth a little bit, okay so be it, but it isn't going to constrain to the extent possible margin.

Okay, thank you.

Your next question is coming from Andrea Jao with Lehman. Please go ahead.

Hello again.

Hi.

Just had a bunch of quick questions, or hopefully what will be quick questions. Last July you mentioned that you had a letter of intent for 10 million in nonperforming loans from a purchaser. And you expected that to close in August. Did that happen? Forgive how dense I may sound, but how did that impact the decreasing number on performers?

When Terry asked me about, quote, the sale of loans, there's two different kinds of sales. Yes that occurred, but it's really a -- it's a -- in my mind, that's not so much selling nonperforming loans, it's having another provider of credit to your customer take the loan off your hands.

Okay.

It's semantics, I guess. But, yes, that did occur but that's something we've been working on for quite sometime.

Okay. That helps. Also, the $12 to 15 million in gains that you expect in the fourth quarter, you mentioned there would be some offset. Will these just be partial off set, and what exactly do you mean by -- what kind of restructuring were you referring to?

I really can't answer either of those questions with any precision, because we haven't worked through the details of analyzing all of those alternatives yet.

Okay. Fair enough.

That's the honest answer.

Okay.

I'm trying to give you some heads-up that there's going to be noticeable numbers passing through this thing, and other ones probably in other categories. So I don't know if -- I can't sit here and honestly say none of it will come to the bottom line or all of it will you but we need to look through a whole series of options in term of what to do.

F air enough, just had to ask. Do you still have 3.9 million shares remaining under your purchase authorization?

Yes.

Okay. And the tangible ratio has bounced back to 661. Are you comfortable right at that level? If not, can you remind us kind of what level you target? What you would be comfortable with.

We were comfortable when it sunk down towards 620 as a result of doing the share buybacks and the purchase of Hudson in the same quarter, and we're comfortable -- obviously a little more comfortable at this level it drives more flexibility.. We like to be in the mid 6s and that's we think that is a good place to be. We can put a band around it, depending upon what we're doing and how we're going to deploy it.

Okay. Fair enough. That's very helpful.

Your next question is coming from Heather Wolfe with Merrill Lynch. Please go ahead.

Hi there.

Hi, Heather.

On the impact from LIBOR this quarter can you tell us exactly how much that was and how it impacted your net interest income?

Yes. It affected the margin in September by about two basis points.

Okay. And what was -- it was -- on the -- I assume just on the lending side?

Frankly, it's a portion of the commercial loan portfolio that is LIBOR based.

Okay.

So it's not a huge effect, but in September, there was this dislocation, and it was noticeable. It had a two-basis point effect.

Okay. Great. And then just on the impact from the 50 basis points that we've seen already from the Fed, I assume you're sort of neutral to slightly asset sensitive.

I would -- yes. Neutral is, I think, is the precisely accurate term. When we run the whole thing through over an intermediate period of time, it comes out pretty much even. So the net effect to net interest income is how we can manage price and volume in the key categories that can effect it.

Okay. Great. Thanks much.

Thank you. There appear to be no questions at this time. I would now like to turn the floor back to Mr. Paul Beideman for any closing remarks.

I have no closing remarks. Thank you all for your attention. And if you have any further questions, please don't hesitate to give Joe or I a call. Thanks.

Thank you. This does conclude today's conference call. You may now disconnect. Have a wonderful day.