Associated Banc-Corp (ASB) 2008 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Associated Banc-Corp third quarter 2008 earnings conference call. 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 today, Thursday, October 16, 2008. I would now like to turn the conference over to the host, Mr. Paul Beideman, CEO and Chairman of Associated Banc-Corp. Go ahead, sir.

Thank you very much, and thank you all for joining the call today. As you can see from the press release, we earned $37.8 million or $0.30 per share. And is our normal course of action, I'll just give you some comments about some of the key components of that and we'll be happy to answer any questions you may have.

I'll start with credit. And as you'll recall, we said our losses and non-performing loans within the third quarter would be in a range around what we saw in the second quarter levels and that's where those metrics came in. Losses were $38 million compared to $37 million, nonperformers were $304 million, up 5% from the second quarter and total provision came in at $55 million versus $59 million.

We continue to believe that that's the pattern that we will see as we go forward into the fourth quarter as well. The composition of the charge-offs are also consistent quarter-to-quarter. The construction losses were $20 million, up from $14 million, the C&I losses were $8 million, down from $14 million, and all of the rest of the portfolios were essentially stable to second quarter levels.

It's clear that the economic weaknesses are going to continue and continue to put pressure on credit quality and it's also unclear as to when those pressures will begin to abate. And it would be naive for us to think that we're going to see any significant improvement around those core economic conditions any time soon, in the short-term certainly. And as a result it's really hard to be optimistic in the short run.

But I do believe with a lot of the actions that have occurred over the last few weeks the government is now doing the right things to begin to put a net under the financial sector and the economy, and that that those things over time will begin to bring some stability to those markets.

Just some other perspectives. Our losses really continue to be largely in our construction portfolio and in those C&I credits that relate specifically to housing. And, obviously, in the first and second quarter we experienced a wave, if you will, of deterioration and here in the third quarter we've begun to see that stabilize somewhat.

Our C&I and our permanent CRE portfolios continue to show relative stability with the exception of those credits that are linked very specifically to housing. Our mortgage portfolio continues to show some deterioration in terms of delinquency and ultimately loans moving into a non-performing status. But our underwriting has protected us and as a result there is very little loss content that's passing through and we can see that now really over several quarters, and our home equity portfolio continues to show some signs of stress, but, again, not meaningful increases in losses.

And so those factors that we have been talking about over the last couple of quarters continue to play through here in the third quarter, as well, and that's how we see things going in the fourth quarter. Moving on to the margin and there was some significant shifts there. The margin declined in the third quarter pretty substantively, and net interest income was down about $6 million from the second quarter. We have said over the last couple of quarters and in our investor conference calls and in our meetings that we believe that our margin, on a normalized basis, will be in the mid to upper $350's and I continue to believe that's the case.

There are a series of variables that affect the margin that aren't deposit and loan volume and price specific. LIBOR dislocation, the level of non-accrual interest recoveries that you receive, commercial origination fees and points, timing of repricing for home equity portfolios, things of that nature. What we saw in the second quarter was really many of those variables going in a positive direction and that margin was up in the mid-$360s. What we've seen in the third quarter is really the converse of that where in virtually every case there's been a negative effect in that short-term period in the third quarter resulting in the margin of around $348.

We are very comfortable beginning to articulate that our normalized margin around the volumes that we normally see are in the mid to upper $350s range and given the dynamics that we're seeing unfold here as we approach the fourth quarter, we're very comfortable that the margin is going to return to those kinds of levels.

Moving to fees, briefly, overall I think our fee income was strong and that continues to be a trend for us. Core fee revenues were up 9% over the third quarter of '08 and we see good growth in our core deposit fees, both on the commercial side and on the retail side. That's being driven from a variety of sources, but really the positive underlying factor that we see now is we're generating sustained household growth through our retail businesses and the absolute number of consumer checking accounts is up 5% this year and the absolute number of business checking accounts is up 9% this year.

And so it's not just penalty fees, if you will, it's the ability to capture the higher value component of those -- of our existing relationships and then having some momentum in the new components of growth as well. Both management is certainly under some stresses and those fee have been relatively flat. We had the one-time $13 million charge, if you will, against -- largely against Fannie Mae preferred stock in the quarter that we have talked about before and we've disclosed.

If you abstract the one-time ups and downs from last year and this year and set those things aside, I think the message that we would like to send is that total revenue, even with the margin decline in the third quarter, is up 6% year-to-date. So total revenue is really showing some good lift and we think that that revenue growth is going to continue in the fourth quarter.

Expenses were essentially flat on a quarter-to-quarter basis and up a little less than 2% year-over-year. And the message there is we continue to invest in our Company. We've invested, as you've heard us talk about before, in a massive new system for the entire operations of the bank. And we went through a very successful conversion in the second quarter around that, but that was a significant investment.

We've also for obvious reasons been investing in adding resources from the senior management ranks right on down through into our credit organization. And even after doing that the head count for the Company remains essentially flat and the expenses are up really only slightly year-over-year.

So we want to continue to focus on making those important investments that position the Company to be stronger while also managing expenses on an overall basis at the corporate level so we're investing in those things that are most important, but using our resources judicially. So I'll stop there and we can open things up for questions.

So sooner or later we will have a question. I know there are several people that want to ask one.

Pardon me sir. I do apologize.

I'm sorry?

I do apologize, sir. (OPERATOR INSTRUCTIONS) And our first question comes from Scott Siefers with Sandler O'Neill. Go ahead, please.

Good afternoon, guys.

Hi, Scott.

I guess the first question I had, while they all sort of revolve around capital levels, probably I guess you expressed some optimism at the plans the Treasury and Fed have come up with, and I wonder if you could talk a little bit about Associated's interest in participating with one of the two, either the [tarap] or the capital injection to the extent you've had time to analyze it?

And I was hoping you guys might have some of your estimated regulatory capital ratios for the third quarter, if you could share those and then give us some of your thoughts in about how your thinking about overall capital adequacy?

Okay. From back to front, in those questions our tangible capital ratio was 6.5 in the quarter and it is stable to last quarter. And we believe that the other ratios will essentially be stable to the last quarter as well.

Okay.

I think that the second phase here, if you will, of what the government is doing to attack all of these issues around opening up credit markets and bringing some safety and soundness to the financial services industry is really a stronger iteration of this whole thing than just buying back the loans would have been. I think there could have been a whole series of unintended consequences around that and the outcome, I think, was less clear.

But if you look at what the government is suggesting today and admittedly it is like way out of -- it just hasn't been clearly defined enough yet to make a decision. At first blush, it appears to be on a relative basis to other Tier 1 capital raising alternatives, from a financial point of view, a pretty attractive alternative. But the certainly devil is in the details.

So we're going to wait and see what those details are and we're going to evaluate the plan with our Board as we meet next week and then at that point we'll hopefully be able to come out with a clearer view of where we are. We're also looking at the FDIC programs that are being put together around expanding deposit insurance and again we think that's a pretty attractive alternative. But, again, we need to understand the details around it and they're beginning to schedule conference calls.

Okay. Perfect. I appreciate it.

Sure.

Thank you. And our next question comes from Andrea Jao, go ahead please.

Good afternoon, everyone.

Hi, Andrea. It's nice to hear your voice.

Oh, yes. Well, with respect to loan growth, last July your indications that the commercial pipeline remained good. It looks like average levels this quarter show decreases for both commercial, commercial real estate and I was surprised to actually see strength on the consumer side.

Yes.

So I was hoping you could talk about the drivers there.

Yes.

And what you're seeing early in the fourth quarter?

Right. Well, let me give you some general views. Certainly, the growth that we've seen on the -- on the consumer side, we felt was a chance to be opportunistic and it gets at adding those households to the bank. And it's a lot more than just loan growth, it's demand deposit growth and fees and relationships and getting -- and importantly it's all in footprint and it was virtually -- well 75%, 80% first lien. So we feel very good about the underwriting quality around that.

What is happening now, I believe in the markets, and it's very different than even the last time we talked on this call, but I think it's different good to some extent, is that credit markets are going to -- and credit risk pricing is going to return to levels that -- where it should be, you know. And so I believe that financial institutions in general, and speaking for Associated, absolutely, we're going to use our balance sheet only for the highest quality transactions that we can generate and we're going to get fully paid for the risk that we're going to take.

And I do not think that the LIBOR rates that we're seeing now are an aberration in any way. I think they're probably going to come off of where they are and for a long, long time never be anywhere near where they were and that's going to set a different standard around loan pricing, which I welcome.

I believe that as we have basically shut off the entire real estate side of the business, we're going to -- we've sort of been breaking even on that right now for the last couple of quarters, but we're going to start to see some significant runoff in those portfolios, which again, I don't believe is all bad. So next year, and it's hard to predict when exactly it's going to begin, but we believe we're going to see substantive declines in our real estate construction portfolios especially, and it probably won't be replaced dollar for dollar with other commercial loan growth in this environment until economic conditions begin to stabilize.

You're not seeing some of your commercial business borrowers draw down lines just to be richer in cash?

We're not seeing it as a macro trend. You can see it in the third quarter growth numbers. Their relatively muted.

Okay. What is notable is that your service charge and deposits were strong and some of the other banks have reported, or are reporting, weak fee income line items all around as a recessionary indicator. Could you talk about that, please?

This is an area that we've been focusing on for 24 months, basically. And we have been making sure that we put the systems and the processes in place and the sales processes in our branches to get paid and to capture the revenue that we're generating. So as part of the systems conversions that we've made, we've upgraded our capacity to capture those fees. And it's not just on the consumer side of the equation.

We've -- as one of our investments, we've been -- we brought in a couple of key people from La Salle, frankly, in Chicago, to help us get at the potential within our commercial base, especially the upper end of it, to capture the fee income opportunities that are resident in that base and those efforts are paying off for us. So I think maybe you could argue that we are getting our share of the business that we should be getting, but okay, I'll take it.

And that was the intent. And I think those growth metrics are going to continue for us.

Fantastic. Thank you very much.

Thank you. And our next question comes from Terry McEvoy with Oppenheimer and Company. Go ahead, please.

Good afternoon, Paul.

How are you doing, Terry?

Great. Two questions on deposits, looking at some of your peers that have reported so far, their money market balances have gone down meaningfully, and it was interesting to see Associated is up about $900 million. Can you just comment on the growth there in Q3, and then the second question on deposits, have you noticed a change at all among your depositors in markets where your Associated is very established in Green Bay and in Milwaukee versus some of your newer markets where you're maybe not a top five in terms of the market share and during these turbulent times have you seen a flight to quality in markets where people know Associated and then maybe the exact opposite in some of the markets where you're just not as well known?

Yes, okay. Good questions. We are seeing outright retail deposit growth in the money market bucket and that's one component of it. Another component of it are deposits from Promontory that we are bringing in that they are a middle -- an intermediary, if you will, between brokerage organizations that are attempting to find insured deposits for their clients and financial institutions.

And we have an arrangement where they provide us those deposits as well. So a portion of those money market deposits fall into that category.

Another interesting dynamic that is going on is the really much more aggressive utilization of something called the Cedars program which is again designed to get deposit insurance for commercial customers or larger customers and that is on our broker deposit line. So you may be seeing broker deposits -- well you are seeing broker deposits increase.

That Cedars program increased 30%, up to about $100 million in the third quarter and although it has to be reported on the brokered CD line, it is core deposits that have moved from some other component of the Company or an Associated customer that brought those deposits in and have taken that product because we offer it. Regarding the market, instead of -- yes we're seeing some flight to quality, certainly in markets like Green Bay where we have a reputation and such a large market share.

But to turn it around a little bit, we're being very proactive in markets like Minnesota and Milwaukee, especially, where we are driving at trying to get the growth there that maybe we haven't seen in the past given our branch system size.

So we're targeting our marketing there and -- and just really going after new household relationships and sometimes that can be with a money market product, sometimes that can be with a loan product as well, in those areas because we've go the wherewithal to grow given the enhanced distribution that we've created over the last few years.

Great. Appreciate it.

But the one thing we're not seeing is any issues at all about customers -- I mean you have your anecdotal stories, but customers coming in and showing great concern about the stability of Associated as a specific institution. We're seeing very, very little, if any, of that at all.

Thanks.

Thank you. And our next question comes from Ben Crabtree with Stifel Nicolaus. Go ahead, please.

Yes. Thank you. Good afternoon.

Hi, Ben.

How are you doing?

Good.

A couple of, I guess, specific questions. Paul, I think you said that credit spreads were going to return to normal. Do I infer from that they are not yet there today?

I think they're going to continue to expand.

Okay.

In fact, they are expanding. They have expanded. They're going to continue to expand.

And I'm assuming that some of that is due to a less competitive attitude by some big banks. I'm wondering if the big banks are also less competitive on the deposit side or are you getting less relief on the deposit side than you are on the credit spread side?

I think we're getting less relief on the deposit side. It's still pretty aggressive there. And okay, it is what it is. Certainly, having an interest rate cut bodes well, I think, for taking some pressure off of that side, perhaps. But I think -- I think even the smaller banks at this point are getting religion around loan pricing.

Okay.

I think that's going to -- I think that's a secular trend you're going to see. I hope anyway.

You're right. To what extent is the LIBOR versus prime mix important to you? Do you have one part of your balance sheet more tied to one or the other or are they pretty well balanced?

Historically, we've been on the commercial side using LIBOR and prime. But for all intents and purposes now we're a LIBOR based organization and I think that's the way the trend is going.

Great.

On the consumer side, on home equity and stuff that different.

Right.

But we're basically driving our commercial businesses to LIBOR based pricing without exception and we're being more and more aggressive on the utilization of our [floors.]

I was interested in this whole issue of kind of expanded or even unlimited insurance on commercial deposits. Have you detected any uneasiness on the part of some of your commercial depositors to get the balances too high?

I think it's a great response to the whole issue around risk. And if it's too consumer focused, you're missing the small business sector of the economy because it doesn't take much for a business to have to have $250,000 on deposit on Friday to meet their payroll.

Right.

And my view is, the more aggressive you are with the policy around the insurance and the guarantees, the less likely you ever have to use it.

Just a couple of more. The home equity trend, I mean you've within talking for a while that it looked as though the credit quality pressures there were approaching some kind of a peak or at least the intensity was not going to be growing and it sounds as though that's true.

Are you -- I guess I would like to approach that from both a severity and frequency standpoint. Are you -- are the losses, when you take a repossession, are they staying stable? Are they getting better? What is the inflow looking like in that whole loan category?

Yes. Okay. It's different geography to geography. Our weaknesses still continues to be Minneapolis.

Okay.

And the biggest deterioration around the ability to hold collateral value and that sort of thing and the loss content is there. The good news is we're working through that piece of the portfolio that we talked about before that is somewhat aged from the First Federal acquisition. The bad news is these economic conditions, I think, warrant a view that the deterioration is going to continue.

But on a relative basis, I believe when you look at our entire portfolio and our footprint, you may see more deterioration in terms of delinquency and the like, but that the charge-off metrics aren't going to necessarily go with it. We continue to track and we'll update our desks as we go out on the road again coming up around foreclosures, bankruptcies and that sort of thing and we're seeing some small tick-up in those areas, but again very, very small on a relative basis.

And in fact, it's at levels where it was maybe you know a year ago, where it had ticked up and a little bit and then settled back down again. So it's within a range, if you will, on those leading indicators, not spiking through the roof. And if we had utilized too aggressive practices, undeniably those numbers would be at much higher levels than they are.

Okay. Good enough. Thank you.

Thank you. And our next question comes from Heather Wolf with Merrill Lynch. Go ahead, please.

Hi, there.

Hi, Heather.

Paul, you can walk us through one more time kind of what was happening with the margin and why you do not think that will reoccur?

Sure. I mean, I won't get into tremendous details, but there is a series of factors that affect the margin that aren't necessarily your core loan pricing. They would translate ultimately into spreads certainly because that's where everything goes. But the levels of recoveries against non-accrual loans were at levels that were significantly lower than we had seen in prior quarters. And that we believe that those things are going to come back.

I mean, LIBOR dislocation -- there is just no doubt that at least in the first part of the fourth quarter, LIBOR dislocation, the pricing of LIBOR-based loans is going to become a very positive factor in overall loan spreads in the fourth quarter. It was a negative factor in the third quarter and it was a positive factor in the second quarter, purely because of timing because quarters end on arbitrary days and loans reprice on the first of the month and rates change when they change.

The same principal applies to the home equity portfolios, where in their entirety, they reprice at an arbitrary time and if actions occur that affect the interest rates in the market and then, therefore, affect the contractual price of those portfolios, they could be arbitrarily positive or negative in a quarter.

Okay.

It's those kinds of things that you just -- you can add them all up and they're all a negative contributor in the second -- in the third quarter. I've been talking to everybody, yes, I think our margin was going to come off that 365 level, but not certainly to 347.

I would not have anticipated that because nothing in our analysis of what our core performance is leads you to that conclusion. So there was a series of a couple, of three or four or five things that just drove it to that level and each of one of those things is a million dollar increment.

I understand what you're saying about the LIBOR pricing. But in theory won't the -- if you continue to see increases in nonperformers won't that continue to weigh on your margin in future quarters?

Certainly. And that's a level -- well into the third quarter nonperformers only went up $15 million. In the second quarter, they went up much more significantly. So you can argue that the second quarter had an effect on the third.

The net affect of that in this whole calculation is -- I mean it had an effect certainly, but it's not what I would attribute the decline from 365 to 347 to be, and I'm certainly taking it into consideration when I think about how the margin should be more in the mid-350s going forward. I mean in the fourth quarter, there was just a 50-basis-point reduction in the Fed funds rate.

That is going to bode well for the -- set the deposits and loan as side -- the investment portfolio yields are going to be pretty stable and the wholesale funds are going to come off 50 basis points that day. And then you've got the seasonal demand deposit effects that always occur positively in the fourth quarter. So all of those variables from my point of view make me comfortable in suggesting that it's not a structural shift to 347, it's an aberration around some of these other factors that will return to a more normal level.

Okay. And then can you just address the 25% quarter-over-quarter increase in commercial real estate NPAs? What product was driving that?

Construction. And a small deterioration in the permanent CRE portfolio. But the lion's share of it is in construction. I'm sorry. Are you talking about non-performing loans?

Yes. And you break out construction.

You're right. I'm sorry. The level of nonperforming loans -- I heard you and I'm answering a different question. I'm sorry. The nonperforming construction loans actually went down a little bit in the quarter and that's because what we did -- we actually did sell one fairly large transaction.

The permanent CRE portfolio did reflect for the first time this quarter some deterioration. The nonperformers in that portfolio went from $42 million to $52 million on the basis of what, $3.6 billion. And, yes, we've had one or two credits show some deterioration there and move into nonperforming, but we're not seeing that as a macro trend within that portfolio.

Were there any specific product concentrations within commercial real estate like strip malls or hotels or -- ?

No.

Okay. And what was the dollar value of that construction project that you sold?

$25 million.

Okay. Great. Thank you so much.

Uh-huh.

Thank you. (OPERATOR INSTRUCTIONS) And we have a follow-up question from Andrea Jao. Go ahead, please.

Hello, again. In past times of economic weakness, where have commercial, commercial real estate and consumer NPAs and net charge-offs peaked and why do we go back or not go back to those levels?

When did they peak and where?

No, no. At what levels? At what percent levels did they peak?

Andrea, this is Joe.

Hi, Joe.

Our historical performance here at Associated Bank, we passed through all of those peaks long ago. If we go back to the early 90s and we're looking at commercial real estate losses, we were sub-20 basis points in losses.

So again, in our history, the peaks were numbers that we've been through for a while now, for the last two quarters at least. So when we look at it, it's difficult for us to answer your question, if you're asking about Associated versus --

Specifically. That's how I heard the question. And that's right. We're through Associated's peaks.

If you look at the construction portfolio, we are at about industry peaks. Recognizing it's hard to apply anything going on in this cycle to any other cycles. And Associated's construction portfolio is a little different in this cycle than it would have been in prior ones because of it's composition.

And I don't have real good recollection, but if our non-performing loans approached 1% of loans in our history, that would have been really high. I don't think we've ever gotten that high, so obviously we're a lot higher than that today. Again, not specific products, but just generally.

This may be an unfair question to ask.

That's all right.

But how much more is there to go?

If you would have told me where we were going to be a month ago today, it's in your mind's eye in terms of where you think the economy is going to go, I guess. We believe in that construction portfolio we have been pretty aggressive and we have our hands around the risks as we see them. And we dealt with that in that wave effect, if you will, in the first and second quarter.

The good news, I think, we have dealt with a large portion of the credits that we -- while working with customers within our market, expanding with them into some other out-of-market conditions, areas. There is still a couple of credits that we're looking at, but we think we've dealt with the lion's share of it. We feel -- we still feel pretty good based upon the metrics I was talking about earlier, about our non-housing related C&I portfolios and CRE portfolios and consumer portfolios.

Are we going to see deterioration in these market conditions? Certainly, we will. But we do not see it as a wave. We do not see it as another wave, we see it as credits that we're going to deal with. Unless those economic conditions were to substantively shift towards the negative.

And that's where the -- sort of the eye of the beholder. Where do you put that economic scenario out three months and out six months from now and how do you gauge the exposure?

Great.

I'm telling you how we see it, at least for the last three months, I think we've gotten it pretty close.

Okay. Fantastic. Thank you.

Thank you. And our next question comes from Andrew Marquardt with Fox-Pitt Kelton. Go ahead, please.

Afternoon, guys.

Afternoon, Andrew.

Following up on the comment made around Heather's question, I believe you sold $23 million of a construction loan during the quarter?

$25 million.

$25 million. Were there any other loan sales during the quarter?

No. That's the only loan sale we've made in the last -- at least the last three quarters.

And was that already charged off? That was on nonperforming?

It was on nonperforming.

And did you take additional losses on the sale?

Yes, we did.

Okay. Thank you. And ladies and gentlemen, this does conclude the question-and-answer session for today. I would now like to turn the conference back over to Mr. Beideman for any closing statements.

Are we sure there were no other questions? I have no follow-up comment. If that's all of the questions, then thank you all very much for participating.

Ladies and gentlemen, this now concludes the Associated Banc-Corp third quarter 2008 earnings conference call. Thank you for your participation, and you may now disconnect.