Associated Banc-Corp (ASB) 2008 Q1 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Associated Banc-Corp. first quarter 2008 earnings conference.

During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (OPERATOR INSTRUCTIONS) This conference is being recorded April 17, 2008.

I would now like to turn the conference over to Mr. Paul Beidman, Chairman & CEO of Associated Banc-Corp., please go ahead, sir.

Thanks, Nicole, and Lisa Binder and Joseph Selner are on the phone call as well; and I want to thank you all for joining the call.

As you can see from our press release, we earned $0.52 per share in the first quarter, and we're pleased with our revenue dynamics specifically with how net interest income continues to improve. We're seeing sustained loan growth in the target categories that we've been talking about, and also we're seeing improving deposit flows, which are contributes to that net interest income growth.

Our credit metrics are largely as we have forecast them to be with increasing MPAs, but losses remaining stable to what we have seen in the fourth quarter. There are several one time items that occurred in the quarter that largely offset each other. We have a $5 million gain from our interest in the Visa public offering, a reversal of tax reserves for about $4 million.

Fair value accounting changes that impact our businesses by about $1.5 million. We booked an expense for a $2 million increase two reserves for unfunded commitments. We had a $3 million charge for other and temporary impairment which relates to our Freddie Mac preferred stock and took a provision in excess of losses of about $7 million. So that's some noise in the quarter.

Let me get right to a discussion about credit and I'll make a few comments and we'll take certainly all your questions later. In our recent presentations and discussions that we've had with investors, we've been articulating that losses would be in a range similar to what we have been seeing recently, that non-performers would continue to increase, and that we may be providing at levels that are higher than charges; and losses were 16 versus 15.5 in the fourth quarter. MPAs did increase by 25%, and the provision was $7 million higher, moving the ratio of allowance to total loans from 1.29% to 1.32%.

The MPAs are reflecting really the deterioration of four credits in our corporate banking business; and certainly, there's a lot of movement that occurs in and out of all of these categories, but the net effect other than these four credits is relative stability. And we spent a lot of time talking about our portfolios that maybe a different way to look at it, to put some perspective on it is to think about it from a line of business point of view.

In our consumer businesses, we're seeing and continuing to see relative stability in terms of the overall performance of our mortgage and our home equity portfolios. The regional banking businesses, C&I lending and CRE as it relates to the regional banking commercial business is also reflecting stability. Our program that we've been working on for several quarters to identify deteriorating credits and then exit those credits really has been quite successful in this segment; and even in this challenging economic environment, we're not seeing increases to non-performing loans I think as a result of those efforts. And we're all really very pleased with how our managers and our bankers have embraced this program and have executed and the results that it's showing.

Our corporate banking operation which six months ago had virtually no non-performing loans has seen some deterioration and that deterioration is occurring in businesses and credits that are linked directly to the challenging housing environment, and that really is the single largest contributing factor to the increase in MPAs. Losses have remained stable and as we have stated, we did tighten our underwriting standards really across our consumer businesses some time ago and have been focusing on deemphasizing real estate to the extent that we can. And that while these MPAs are elevated we believe that we will continue to see a similar relationship between non-performing loans and charge-offs as we have seen over the last 18 months.

I'm sure there'll be a lot of questions around credit and we can delve into these issues in more detail during that phase. Net interest income was up over the fourth quarter and significantly up over last year. And we are really very happy with the dynamics around net interest income and the improvement that we're seeing, both in terms of loan growth and overall deposit levels.

The growth metrics that we've been articulating in our strategic discussions really are beginning to take hold in the business; and deposit levels, although certainly impacted as they always are by first quarter seasonal factors, are measurably improved from prior first quarter periods. Over the last several years, deposit outflows have been significantly higher in DDA and in other core categories than we've seen in the first quarter this year and we're very, very happy with that.

All banks at this time really are experiencing the same challenging credit environment and it's certainly been impacting Associated's performance; and the future course of the economy remains unclear. I think interest rates coming down is taking some of the pressure off of the recess of mortgages and the like and taking some pressure off that business; but certainly all the factors around the economy still remain uncertain so it's difficult to predict with precision where you're going to be.

But at this point, there seems to be more and more clear differentiation among financial institutions and their risk dynamics. From our perspective, the companies that are going to succeed in this environment are going to have lower absolutely losses and also create positive revenue momentum so that when the credit environment does stabilize that the stabilization will occur faster and that the positive revenue dynamics would begin then to start to translate into real earnings momentum.

And that's really the approach that we're trying to take in terms of the risk management but then also the business management around revenue creation within our businesses; and we've been talking about that for sometime, and we think that we've begun to show some real progress there. We believe that we understand really where we are now in terms of the credit metrics of our portfolios and the credit metrics of our businesses much more clearly now than we have really at any time in our past and that helps build some confidence around these things as well.

The uncertainties, obviously, are around the depth and level of how economic conditions improve or deteriorate, and--but on a metrics basis, we believe we have a pretty good handle of understanding regarding how these portfolios are performing. Just quickly, expenses and you can see and read it from the tables, expenses seem well controlled in the first quarter, staff expenses down and overall expenses down from the fourth quarter; and fee income which is certainly affected by seasonal conditions in the first quarter from the fourth quarter--the core fees compare I think favorably to the first quarter last year with some stress perhaps on asset management largely from a deterioration that we've seen in market valuations.

So in summary, that's really how we see things in the first quarter and I'll be happy to open things up for questions.

(OPERATOR INSTRUCTIONS)

Our first question comes from the line of Andrea Jao with Lehman Brothers, please go ahead.

Good morning, everyone. I mean good afternoon.

How should we think about the mortgage banking line going forward, is the fair value adjustment just this quarter?

Since this is the first quarter where the accounting standards have changed, that's sort of the entry that defines the difference, if you will this quarter, so we've highlighted it as a one time item. It will have an effect going forward based on a whole series of variables that can impact it certainly, but it's a change to what occurred in this quarter and we felt it should be highlighted.

Andrea, this is Joe.

Again, the accounting rules allow you now in terms of the fair value measurement, it allows you to count the servicing asset in the fair value measurement, and that is now a permanent change, so each quarter as we have commitments and we have closed loans, we'll be able to count that value. This is just a change in how we're recognizing it and it will be permanent now. So you should think about it as part of our evaluation every quarter. I guess it's recurring in the sense that it will happen, but this is the first quarter where it changed.

Okay. I guess that begs the question how should we think of a run rate?

It's very difficult because the essence of the change is creating volatility.

Okay.

And so it's very, very challenging to predict. It's volume based, it's execution in market space in terms of the sale of mortgages in the secondary market. All those variables. It's about as predictable as the MSR. I would suggest to you that the way we try to think about is we try to think about the activity, and the activity in the mortgage banking business has been strong in the first quarter; and we're seeing that continue.

Now will the marks at the end of the quarter be the same direction, the same magnitude? That's difficult to tell because it's a point in time mark, but I think the fundamental business is doing okay.

The fundamental business is quite strong right now as interest rates have come down, and I probably should have commented on that. This is the first time really in the last five years where we're starting to see an environment where mortgage demand is strengthening in any real way; and I'm very happy to see how the repositioning of our business that we took a few years ago, extracting it from the branches and creating this dedicated force is dealing with it in terms of the successes that the volume--that they are generating.

And I guess, Andrea, the easiest way for me to demonstrate that to you is on our tables. We put mortgage loans originated for sale during the period, we have a table and it was $338 million the first quarter of last year; and this quarter was over $500 million. So again, that's the point. The mortgage is doing pretty good.

Okay. Great. I was just hoping to get a bit more detail on your outlook on loans. Can commercial and home equity continue?

We believe that it can.

The momentum that we're generating is coming from a whole series of initiatives around improving our selling and marketing effectiveness and it's coming from business sources from--I'll say it this way, we're able to get this business on our terms. We're underwriting it and originating it based upon the standards that we've put into place. That's not changed, in fact, if anything it's tighter. What's changed is the capacity to execute.

And for example in the first quarter, our regional C&I business had its best production quarter of the last eight quarters, and home equity business--I mean part of it is that interest rates have come down and some of it is first liens which frankly we're very happy with; but just to give you some color, the LTV on the first liens is about 58% with average FICO scores of around 760. So there's an opportunity and a first lien position is a more attractive position and about 70% of it in the first quarter was first lien. We feel good about that and we believe that this is a time that you can begin to be opportunistic if you maintain those standards.

Okay, looks like you guys are in a good place. Okay. Thank you very much.

Thank you.

Our next question comes from the line of Terry McEvoy with Oppenheimer. Please go ahead.

Good afternoon.

Hi, Terry.

Is it strange for Associated Banc to have four credits of that size, about $50 million kind of move into non-performing status? Was there a specific review of a portfolio done in the first quarter, I think Paul you had mentioned it was related to the housing market? It just seems a little strange.

Well, I've been here for five years, and this corporate portfolio has been pristine for all five; but it is comprised of larger size C&I loans, and commercial real estate loans that we've sliced and diced for folks in our recent presentations; and it's clearly a function of those few credits that are linked to, well, the deterioration is linked, thankfully to a few credits, not a portfolio, but a few credits that have deteriorated that are linked to the real estate construction--the home construction specifically component of the business.

We have gone through--both in our regional portfolios and in the commercial portfolios an aggressive systematic review of all the loans in it; and the non-performers that we're seeing here are a reflection of that and obviously the clear deterioration of the credit. I believe and we've talked about this at some of the Q&A sessions that we've had with investors over the last couple of months, that non-performers could increase a little bit more in the second quarter from that review; but again, it's going to be a couple of credits. It's not going to be a portfolio kind of an issue.

And based upon what we see today in the economic environment we're operating in today, we'd like to think that after that, we're going to see things be a little more stable. Now, why do we feel that way? If you think back, we're not--and I guess this is the good thing about being a $22-ish billion bank. There's 400 customers in this entire portfolio.

So can we get our hands around it? The answer is yes, you can. We're looking at 400 relationships in total in the entire corporate bank. So if economic conditions change, good or bad, it's going to affect the portfolio one way or the other, but if we're looking at it today and making some assumptions about how we see it, we feel much more confident as a result of going through this review process that we understand what those dynamics are.

And then in the 10-K I think it was mentioned that you're going to go through a systems conversion of your core banking platform in mid-'08. Any additional expenses and when do you specifically see that happening?

We anticipate it happening in May, and that's still up for some discussion; but that's the plan at this point in time. The run rate expenses right now reflect pre-conversion types of expenses. Over time we believe that the conversion is going to increase our effectiveness first of all because we're upgrading our systems substantively; and can be more efficient as we grow and as we manage and build those systems going forward. We actually see it as a potential when the dust clears to have a small--it's not a massive effect on overall cost, but a slight reduction.

Thanks, Paul.

Thank you, ladies and gentlemen. (OPERATOR INSTRUCTIONS)

Our next question is from the line of Ben Crabtree with Stifel Nicolaus. Please go ahead.

Thank you. Good afternoon.

Hi, Ben.

The salary line caught me by surprise a little bit. Seems like seasonally, that's a number when you get salary increases and go back on FICO and stuff like that, that you normally get a sequential increase and you didn't. Is that part of the cost containment program, is there anything unusual in there, and is this a good base to work from going forward?

There's always moving parts in those things. In the fourth quarter, you remember there was a severance charge in there. Our raises--the vast majority of our raises take effect in March.

Okay.

So the first quarter although it has the Social Security and all that stuff come back in and new pension--or benefits charges and all that, the effective salary increases really won't be seen more until the second quarter. The offsets are is that we are always working on being efficient. If you look at our head count--and I don't have the numbers right in front of me, but recollection tells me that head count is absolutely flat from January of last year to January of this year; and we happened to buy a bank in the middle of the year.

So, we've in essence through a whole series of actions kept the head count flat even though we brought Hudson, which wasn't large, but it certainly had positions associated with it brought into the organization. We've been working down the head count and continue to focus on that all along. So it's a constant investment in business in certain areas and an evaluation of expenses in others, and the net of that is that head count basically is flat year-over-year.

So I would assume that there'll be some small increase to staff expense going forward just because those raises start to come into effect more in the second quarter, but then we're going to continue to work on ways to be more efficient as well. In a nut shell, it's a decent base from which to work.

Okay, great.

The tax rate--obviously, you got a special benefit here, but looking for a little bit of guidance. I've been using 32 going forward. Is that a reasonable number?

Yes.

Then maybe question or two following on relative to the large credits. Maybe I'm reading too much into it but it seems like some of your recent hires have been more oriented towards the large corporate business; and I'm just wondering, Paul, if by moving into that space if you're kind of building more volatility into your numbers with higher average loan size and things like that whether or not you kind of lose the small variability factor that's been true for Associated through most of its history.

I don't think the nature of the Company changes. We've been in the corporate banking business for a decent amount of time before I even got here. So it's long before five years ago. The hires that we're making are part of the strategy to get us better positioned in the stronger market from one point of view. So it's an investment in capacity to grow, but it's also an investment in the capacity to diversify the revenue streams from this business segment.

We're bringing in people into the organization that have expertise in cash management and fee related aspects of this business that can allow us to broaden those relationships out. So it's less a lending focus, lending driven business, and more of a value relationship oriented business. So you can do the lending, but then we can maximize the return on equity and the value that can be obtained from the other ancillary businesses that the loan can support; and the other point I'd like to make is that we're seeing some credit deterioration, and I think the reasons for it are obvious.

From my five years, I said this portfolio has been just pristine, and it's been managed well as it's been built, and I think that's evidence of it. In this review process that we have gone through, we've gone back and looked at these loans very, very closely; and there's really very few of them that I would suggest that we would regret having made. It's good high quality customers that have been in existence for quite sometime that for the reasons that, again, that are obvious, their prospects have deteriorated.

But if we've underwritten them well, if the land is a 65% loan to value and we've applied conservative general standards to it, okay it's a non-performing loan, but we're not going to take a 40% to 50% charge-off on the thing. If there's a charge-off in it at all, it's going to be relatively small, and in many cases it's our hope that it just doesn't exist. The optics of non-performing are affected by it because of the nature of a real estate transaction; it takes longer to work out of it.

Could we sell them? Probably at some point we could, some of them. But in this environment right now, the losses you're taking is exaggerated because of the--just the nature of the markets and the demand; and when we see our collateral position, it's much enhanced over what those levels of alternative would be.

And these four loans, have they been on the books for a while or are they relatively young for you?

They've been on the books for some time and they've been relationships that we've had for some time.

And then if I could shift gears for one last question. Paul, in going back to when we talked in Chicago a few months ago, you were seeing a little more rationality in loan pricing beginning to enter the market. Just was looking for an update on that. Has it held, and are your still feeling fairly good about that issue?

A little more. I believe that--from my perception banks are being way too aggressive given what the credit spreads can be, and it's my expectation in our organization that we're going to maintain that discipline and that we're going to continue to work to improve the relative--the absolute credit spread that we're getting; and that's part of the discipline in this environment, and banks should be able to get it.

The competitive factors and some irrationality drives--I'll call it overaggressive behavior relative to all other credit alternatives that are out there. Banks in today's environment should be capturing higher credit spreads. That's a theory, the practice is intense competition takes some of that away; but we're going to keep driving at it. And, yes, I do think it is getting better, and I do think that on the deposit side of things, some of the pressure is beginning to be relieved, but it's still--it's not where it should be.

Great, thanks a lot.

Thank you.

Our next question is from the line of Scott Siefers with Sandler O'Neill. Please go ahead.

Good afternoon, guys.

Hi, Scott.

I think most of my questions have been answered now, but Paul, I was just hoping you could expand a little on something you said at the outset and then maybe you touched on it a little in responding to the last question; but you made the comment about improving deposit flows which I only found it surprising in that this tends to be your weakest quarter, so I guess I'm wondering what kind of things you guys are focusing on; why you think things are--I guess I took it to mean that things are perhaps a little better than they usually are this time of year, just the overall dynamics on what drove you to make that comment if anything?

Sure. I think there's some external effect. As rates come down, it's some pressure on commercial demand deposits does get alleviated. So on a portfolio basis, some of the pressure is relieved just because interest rates are coming down; and I think that has some effect.

We feel good about what's going on inside the Company. Just a couple of facts. Our consumer checking weekly production sales are up over 17% over what they were last year, but our small business checking is up 60% over last year; and as a function of what we would have categorized as a big opportunity where there's been some underperformance as part of what the Company has done and many of the things that Lisa is doing and the management team is doing to focus on that business and we've talked about hiring in business development officers in prior calls, we're starting to see the impact of that. And a 60% increase in small business checking production over time is going to really contribute to that variable.

So in terms of our marketing of our savings products, our money market products and the core selling around the improved home equity and then linking checking products to that selling process, we're seeing services per household begin to increase across the entire portfolio. The measures are starting to move in the right direction, and over time that stuff starts to build. So we feel that although there is some market effect because rates have come down; we think a lot of it is the result of changing the growth dynamics and the sales dynamics in our retail and commercial business.

All right. Perfect. Thank you.

Thank you.

Our next question is from the line of Peyton Green with FTN Midwest Securities. Please go ahead.

Good afternoon.

I was just wondering if you could comment, Paul, on the opportunity to hire additional capacity at this point in the cycle. Is it getting better, or are people still chasing the same talent?

It's hard for me to gauge what's going on in the whole marketplace, it's hard for me to gauge what others are seeing and others are doing; but we've been very successful over the last 12 to 15 months of hiring in a cadre of talent really across our businesses and across our support function from a whole variety of different companies that are enhancing the execution of those business and the quality of the support that they receive. So we feel very good about how we've been able to attract and bring talent in.

It seems to me--my only subjective comment would be it seems to me that because banks are all sort of suffering to some extent here to some level, there's much less attacking of our people by others. There's much less trying to cherry pick our good people which has been an issue for us in some of our markets. Just because they're not hiring.

We are in certain areas, and I mentioned the question earlier before, we're keeping our head count sort of net, but we're hiring in certain key areas. I feel very good about the success that we've had.

Okay, and then in terms of the positives certainly on deposit side activity is getting better. Where are your still not as pleased with progress?

Around the core business--it's still on the deposit side. At the end of the day it's still on the deposit side and it's still on the--although we're seeing progress, the level--the potential of commercial deposit balances and commercial demand deposits still is something that we can improve at. So if there was one area I would really just continue to highlight and probably it's the same one I've been talking about for the last two years is improving a trajectory growth of commercial demand deposits and other core deposits that are linked to those commercial relationships.

Okay, great, and then with respect to the HELOC growth, how much of that--you mentioned that a significant portion of it was first lien. How much of it was first lien versus more typical second lien?

Over 60%. Between 60% and 65% was first lien and our portfolios have been around 35%. So it's a different mix. There's also more--obviously more of a whole loan component to it than a line of credit component to it which historically has been where we have had greater emphasis.

Okay, so you're saying that they're amortizing 10, 15 year loans.

Yes, and because the opportunity is that the housing values have fallen significantly, and if you can do it now at 78%, you're getting a loan at 78% loan to value; and with interest rates coming down, there's a legitimate market there for first loan positions for perhaps more fluent customers to refinance or to move from company A to associate A.

And this is sort of just it's not precise information, it's anecdotal; but we're hearing about a lot of business that would have been more Countrywide-ish or brokerage oriented now coming back towards the traditional bank where I think the trust relationship is a little stronger.

Okay, and so I mean this is--because the jumbo market has somewhat fallen apart, do you think you're seeing the home equity loans basically replacing jumbos?

That could be a piece of it. We're doing some jumbo business in its own right. Our mortgage portfolio is stabilizing to some extent too where it was running off millions of dollars a month, and part of that is some jumbo business that's coming in through the first mortgage channel also. Joe's numbers before don't talk about the HELOC--or the home equity portfolio at all. So we're seeing double almost the mortgage volume in the first quarter. That isn't even in the seasonal peak period, not including the HELOC--or the home equity growth that we've put on.

Okay.

I was talking about the secondary market, not the portfolio piece.

Okay, great. Thank you very much.

Thank you.

Our next question is from the line of Tom Doney with Decade Capital. Please go ahead.

Hi, good afternoon, guys. I was curious.

Do you sell any MSRs this quarter?

No.

Okay, great.

And then I want to make sure I have this right, I may have missed this. So the four MPAs that came in this quarter, it's four loans of $50 million in aggregate?

Yes--or 41--49, yes, okay.

Is there any geographic area within your footprint where these are coming in in particular or is it spread throughout the footprint?

Chicago. There's no rhyme or reason to it. It just happens to be where the business is, but the--there's not a geographic concentration.

Okay, and then you mentioned -- I may have missed it. You mentioned something about credit secured by land; are the MPAs that came in secured by land?

Some portion of them are, sure, but basically because they're in the residential construction--residential marketplace, there's land involved, yes.

Or some stage of development.

Right, it could be raw land or projects that have been built or in a stage of building that--where the demand for purchase has deteriorated.

And because of the size many of these borrowers have multiple projects and they all have different characteristics; but some are in earlier stages, some are later stages.

So are these local builders in regional builders?

They're in our footprint. They're in our market, these customers--these customers are here. Do some of them have products, I mean projects that go a little further than the three states? I can't answer that explicitly, but generally they're Midwestern customers.

Okay. Thank you.

Thank you.

Our next question is from the line of Kenneth James. Please go ahead.

Hi. Good afternoon.

A question on the margin. I was wondering if I could get your outlook there. It seems like given the way the trends are going you could optimistically probably hold this level if not see some modest expansion as we go through the year; would you concur with that?

Yes, and the level with which interest rates fell in the first quarter, created some volatility there certainly. But the margin itself we believe is going to be stable around--I would call a four basis point decline from 362 to 358 stable. In my mind that's not a massive deterioration, especially with some of the volume; and then you've got the seasonal effect of demand deposits that come back in the second half of the year. So when you balance all that out, I would suggest that it's going to remain in that mid-50s kind of an area.

Okay. Thank you.

Thank you. (OPERATOR INSTRUCTIONS)

Okay, Mr. Beidman, it looks like we have no questions.

All right, well then, thank you all for participating and for your attention and questions. As always if--feel free to call Joe or myself with any other questions you may have.

Thank you.

Ladies and gentlemen, this concludes today's Associated Banc-Corp. first quarter 2008 earnings conference. Thank you for your participation, and you may now disconnect.