Associated Banc-Corp (ASB) 2008 Q4 法說會逐字稿

Good afternoon ladies and gentlemen, and thank you for standing by, welcome to the Associated Banc-Corp fourth 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 to questions. (Operator Instructions). This conference is being recorded today, Thursday, January 22, 2009. I would now like to turn the conference over to Paul Beideman, Chairman and CEO of Associated Banc-Corp. Please go head, sir.

Thank you very much and thank you all for joining our call today. Joseph Selner and Lisa Binder are here with me and as you can see from our news release we earned $0.11 in the fourth quarter. With really a significant number of non-recurring items that are imbedded in those results. The largest of those items is $31 million other than temporary impairment mark on a security. And what I would like to do is talk briefly about that specific entry and then cover the core components of our earnings, which really on several fronts we feel pretty good about. And then as usual I'll open the call up for your questions.

In the quarter, we took a $31 million write-down on a mortgage-backed security whose market value declined significantly in the quarter. Throughout 2008, even as late as the end of November, the security was trading above $0.80 on the dollar. However, in December it was downgraded as its market value declined significantly to $0.50 on the dollar. At this point, we continue to receive the cash flows from security as agreed. Losses are low, below 1%, but the deterioration in the market value really drives the assumptions that cause the [OT] -- TI mark to be set.

As you know our practice is to buy agency-insured securities, and we have on our books $3.7 billion of mortgage-related securities, $3.6 billion of that $3.7 billion are agency-secured. And of the remaining $100 million, $70 million are a result of acquisitions from First Federal and even as far back as First Financial. So they are well-seasoned. And as a result we believe that further exposure to this type of a market is very limited. Moving on then into the core components of our earnings announcement, first with the margin, again, as you can see net interest income for the quarter was $192 million which was up $25 million from the third quarter and the margin was 3.88% as compared to 3.48%.

In terms of the balance sheet impacts on the margin, we saw really good deposit growth across the board. DDA and interest-bearing demand deposits showed solid growth with DDA up 10% and interest-bearing DDA up 7%. As we know some of this is seasonal but we continue to see good momentum in terms of consumer household growth and growth in small business relationships. And over the longrun that is going to continue we believe to drive sustained growth in these low cost deposit categories, which are so important. Loans were essentially flat in the quarter with some small C&I growth off set by declines in real estate construction. And spreads on loans continue to improve in this environment. A significant portion of the margin expansion that we saw in the fourth quarter was a result of interest rate volatility.

LIBOR dislocation which was incredible during the quarter certainly, and the aggressive declines in interest rates that we saw in the quarter. And we talked really about this over the last several quarters. And I continue to believe that in a stable environment, our core margin is in the neighborhood now of perhaps 3.60%. In that neighborhood. And I am also convinced that over the next couple of quarters what we're not going to see is a stable environment. And there will continue to be volatility there. But loan pricing and loan yields, loan spreads are continuing to improve as we build pricing discipline into the equation but we continue to be pressured on the deposit side of the equation with competitive pricing and I think those trends are going to continue. And I think interest rate volatility will continue to have an effect on the margin. But our stable margin is in the neighborhood of around 3.60% at this point, we believe.

In terms of our execution around the key variables of margin, we're going the continue to focus on executing our strategies which we have talked about in the past and continue to focus on. Which really are around growing low-cost deposits on a sustainable basis with quality consumer and C&I loans, and very importantly on sustainable focus on core fee income growth. And over the immediate term we believe that driving those dynamics and continuing to show growth there is going to position the Company well for the future and help us maintain the sustained earnings that are necessary to deal with the challenges in the credit market.

After receipt of the capital infusion from the treasury, we also purchased $1.7 billion of agency-insured mortgage-backed securities. Obviously at a macro level, this purchase certainly supports the mortgage markets by freeing up capacity as volumes now, since rates have come down as volume of mortgage origination are increasing, but it also provides Associated with an additional source of earnings for a period of time that can offset a portion of the dilution that is resulting from the capital infusion. So the purpose there is to deploy a fairly small amount of capital, and against this type of security the risk-based capital is 20 basis points. So it is not a significant deployment of capital, but it is an opportunity to generate safe sustainable earnings with very little liquidity and interest rate risk to generate that source of earnings to overcome the dilution and work to maintain a more stable level of [attained] earnings.

If I could just -- shifting asset-quality, you recall that since really to the end of the second quarter we have been projecting that losses and provisions would be in a range around those second quarter levels. And more recently as we have seen the deterioration beginning to occur in the economy more severely, that we have been concerned that we could see additional deterioration as a result of the economic weakness and the potential for some expansion outside of losses that have really been contained to retail -- or to residential construction and to see that stuff begin to spill over in other sectors. The fourth quarter results, I think do align pretty much with what we have been taking about in terms of being within a range around those second quarter levels but with some seeing of some small additional deterioration and not seeing that wave effect that we had all experienced in the first part of 2008.

Our fourth quarter total provision is about 10% higher than the second quarter levels. And we have seen some additional weakness more broadly in our portfolios. Charge-off's are slightly elevated, MPAs increased by about 11% and provision continues to be an excess of charge-offs reflecting those weaker economic conditions. Having said that, we're not experiencing the significant deterioration seen more generally in the industry. And we continue to believe those charge-offs and profession levels will remain in a range at these kinds of levels for the first half of 2009.

At some point and it is really difficult to be precise as to when this can start to occur, we believe that the level of deteriorating commercial credits is going to begin to subside and as a result the pressure on continuing to provide provisions at levels significantly higher than charge-offs is going to begin to ease. So even if charge-offs remain at those elevated levels, the level of provision would begin to subside a little bit, and that cost lever can start to become a positive. That happens as we continue to realize the reserving needs against our deteriorating credits and we get ourselves more and more focused in to our core Wisconsin portfolios and into the smaller credits. If we have done a good job of recognizing where we are in our construction real estate portfolios and in the larger credits, which I believe we're really getting at, eventually we'll see this Wisconsin base of business become a benefit towards reaching a level of stability.

Switching to fees, fees are up, core fees are up 6% over the fourth quarter of 2007, which to me is the best comparison year-over-year. And while trust fees are down significantly for obvious reasons in terms of market conditions, service charges and card base fees and commissions are really all up. reflecting household growth, increase commercial banking fees which has really been a powerful contributor for us and increase car usage. And those core fees are continuing to show good growth in a challenging environment with trust pulling that number down somewhat.

Mortgage banking income was down in absolute terms in the quarter, and also in comparison to year-over-year. And this is due exclusively to $7 million valuation charge to the mortgage servicing rights. It is important to note that in December with the interest rate movements that we've seen, mortgage origination volume for us is up 200% in December over November levels and obviously quarter end at an arbitrary time. So we felt the full effect of the MSR valuation charge in the fourth quarter and very, very little benefit of that increased mortgage application volume.

So while we're seeing significant amount of increase we believe that we're going to see that volume close certainly in -- or for the first quarter of 2009. The MSR valuation certainly is a wild card. And if interest rates continue to go down or if mortgage rates are driven down and pre-payment fees increase, obviously there would be some pressure on the MSR. But we're going to have to volume levels ramped up to a level so at least the natural hedge is going to be there. And eventually that volume, that positive volume will begin to pay us to the end of the numbers and hopeful about mortgage business in 2009.

Expenses are up $12 million in the fourth quarter over the third quarter. And I would say that virtually all of that is as a result of items that I would categorize as nonrecurring. We have a fraud matter of some size which is quite unique for us in that quarter. A large OREO write-down, which again, is pretty unique. A whole series of nonrecurring legal expenses obviously relating to the due diligence and exercise around an a agreement with the treasury regarding the TARP funds and other expenses there, and elevator occupancy expenses largely associated with weather.

Going forward, we expect that our expenses in 2009 are going to settle back into more stable levels. As with everybody that has got deposits, we're going to see a $20 million increase in costs from the FDIC associated with deposit insurance but we are also taking a series of initiatives especially focused at non-staff expenses to bring efficiency to the table. And we believe that next year our expenses overall are going to be up maybe slightly over 1%. So virtually flat, as that is the approach we're taking there. So those are the comments across the variables of our earnings. And we'll be happy to answer any questions that you may have.

Thank you, sir, we'll be happy to begin the question and answer session. (Operator Instructions). And our first question comes from Scott Siefers with Sandler O'Neill.

You agrees addressed the margin and volatility that was created by interest rate movements. I wonder if you guys would be comfortable giving the margin maybe by month, just to give us sense as to sort of the where it settled out toward the end of the quarter.

I can tell you it was a little lower in December than it was November. And if you think about it. One month LIBOR in October was 4% and in December it was 4/10 of 1%, so that type of volatility drives it. But it was -- it was high really through all three months. And it is -- still a challenge to predict how it is going to play out with this kind of volatility. But it was slightly higher in October than it was in December.

Okay, and if I can jump over to credit for a second. I guess I -- would just like to get a little bit more of a sense for -- sort of the mix of -- of any deterioration you have seen, kind of construction versus other. Might you be able to sort of -- say you know how much in the fourth quarter of your charge-offs was construction-related versus other. And how would that compare to maybe say the third quarter?

Sure I'll be happy to do that. The lion's share of the increasing nonperformance loans and in the charge-offs both was in C&I, and, in fact, 22 million of the $30 million of nonperformers were one large C&I loan. Construction and I'm not going to call this a trend but you have to have one quarter before you can have a trend , construction nonperformers were down almost 10% and construction charge-offs were down as well. So -- I categorize our C&I losses as choppy. And it is going to be very credit by credit-related. In one quarter, they will be elevated and in the next quarter they will be lower. And we don't see like a sustained massive deterioration there. So this quarter we had one large credit with a $5 million charge-off and a $20 million remaining component to nonperforming. And that has been the major driver of the metrics. Our CRE portfolio, the nonconstruction CRE portfolio had a tick-up in nonperformers but the charge-offs were down slightly. Mortgage charge-offs flat as a pancake, home equity charge-offs up a small amount. So really the delta is the -- one large C&I credit. C&I charge-offs in the quarter -- in the third quarter were 8 million, in the fourth quarter were

Okay.

So that is more than all the difference. Construction was down, CRE was stable. We get asked a ton of question, and legitimately so about our consumer books. Home equity and residential mortgages. And I continue to harp on the fact that these things are relatively well-behaved because of the nature of the underwriting associated with them and the mortgage charge-offs are flat to the third quarter and home equity up slightly.

Okay, and then I guess the final question I just wanted to make sure, I heard you clearly on the experience outlook. You talked about 2009 expenses up 1% versus 2008. Was that just the nonstaff? Did I hear you correctly?

What I tried to say, maybe I went to fast. But I'm going to say our expenses are going to be up 1 to 11/2%, total expenses, even with the 20 million of FDIC Insurance. So we're taking steps to control other aspects of it and not let the $20 million of expenses come through.

Okay, great, thank you very much.

Sure.

Okay, thank you and our next question comes from Terry McEvoy with Oppenheimer.

I won't ask a tough question because it sounded like you dropped a baseball bat in the middle of your prepared remarks.

That happens occasionally.

I'll keep it simple. You had really good growth over the year in the home equity category. But there was an up-tick in the charge-offs of home equity. Is any of that some of the newer loans that have been put on the books over the past year. Or has it continued to be kind of legacy Twin Cities home equity that came from an acquisition?

None, none associated with the new stuff. Of all the -- credit metrics, if we break our -- home equity portfolio into timing of its and the characteristics of it, the cleanest, best stuff we have got is the new stuff. And it continues to be deterioration that we have seen from the same sources throughout the year.

Great, and you continued to have really good deposit growth in the fourth quarter. Without naming names, is it coming from the real small banks? The big banks? Is there a sense at all where those customers are coming from?

To tell you the truth, sitting here at this time in January I don't have information that would give me that. I have anecdotal information, but I believe it is -- it is the activities of our people, of our colleagues in the branches and commercial banking that are out there with a renewed focus. And better product arsenal to work with. And that is where the fee increases on the commercial side are coming from as well. So I think it is sustained. And it is taking business from others. But I can't tell you with precision and tell you from who.

And then just one last question, can you update on the board's thinking with regards to the dividend policy going forward.

Sure, the board will meet next week. But if you look at our retained earnings on a core basis, I would be very reluctant to think about changing the dividend. And our plans for next year and our approach -- if you look at the core of this thing from my perspective, it is earning $0.30 as a share area. And that covers the dividend. And that is our intention next year to cover it and to earn above it. And our plans are being laid out and our focus on execution is designed to approach it that way. So I -- I feel -- pretty good about at this point recommending that -- that there is really no, no changes that we're anticipating, at least here in the short run.

Thank you.

We think about it -- each quarter now very, very much in a focused way. And if dynamics were to change, then that is different. But like I said, our goals and objectives for next year are to earn in those levels that exceed the dividend. And our objective is to keep it in place to fight to do that.

Okay. Thank you.

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

Thank you, good afternoon. Couple of questions, looking below the reported numbers of nonaccruals in 90-days. Any comment on the shorter, the 30 to 89 days delinquencies, you show pretty nice trends in the early stage delinquencies, early quarters. And what is going on there?

Well, I can tell you that we're continuing to reserve charge-offs, and that is a reflection of recognizing I think some deterioration in the core commercial credits. And seeing some some migration there. That's really the core driver of that provisioning above charge-offs. And that was to the comment that I was making earlier. Sooner or later we're going to catch up to that. And the banks that start to get the provision number to come in and aligning itself towards -- toward getting the provision back towards the charge-off levels, is where some operating level is going to be created. On the 30 to 89 day delinquency between the third quarter and the fourth quarter is flat.

Okay.

Down a scrooch but I'll call it flat.

In relatively good performance? Then the -- the issue of -- I guess I have been waiting for deposit competition to get rational for an awful lot of quarters here. I would seem like we would be in the kind of environment where people -- your competitors would be concerned about margins, things like that. So I'm going to scratch my head. And you're not the first one I have heard it from. The question is I guess -- where is the greatest pressure coming from on the deposit side? And are there any signs, say so far this year that it might be getting a little less irrational?

Yes, I think that rates are beginning to start to come down. And perhaps earnings pressures are going to get some more rational behavior around those sorts of things. But you're not going to get deposit prices down to where they rationally ought to be as compared to fed funds. And the temptation is gee, if I go to fed funds and make some money off, I'll make some money here in the sort run. You just can't do it. You have to focus on a sustainable basis growing core deposits, especially the low cost ones. And to not get sucked into this gee, I can turn it on and off like a switch. Have to position the business to be sustainable going forward over an intermediate term as you start to think how you're going to come out of this, and you can't compromise your strategy. You want to get the price down to the lowest level humanly possible can. But you got to grow.

That then shifts the question on how are you going to manage list on the loan side, on the asset sides of the equation. And how are you going to price extremely rigorously there with the discipline that allows you to get the right return. And it is an upside down place from four or five years ago, two or three years ago. When credit is too available and life is cheap and life it good. If you are going to risk the banks capital you better get paid for it and you better get all the fees and you better get the deposits or else we're not going to do it. And there is just no room for movement on any of that stuff. That is why I have a strategy that is why you focus on how to do it and spend all your time.

But if I could go back and compare what you were saying 18 months ago, you were on the credit spread side of it, you are now plan to get paid for the credit risk?

I agree, that is one factor in the market that has indeed changed. Now we -- I was on the phone with Senator Cole's office in Wisconsin a few weeks asking what are we doing with the TARP money and how are you deploying it? We talked about the $1.7 billion of mortgages, we also pointed out that from the middle of November to the middle of January, we either originated or renewed $1.8 billion worth of loans. So we're doing lending, we're lending money, we are working with our customers. It also gets in, you can see how much churn is going on in the world if you're doing $1.8 billion of loans and the volume is relatively flat. But that is still lending money. And as that stuff turns as you get that churn and you are focused with discipline, you have an opportunity on that side of the equation to allow yourself to grow deposits relationships profitable, even in this sort of exaggerated environment.

And then one last question, would you be all to comment on the spread with the very leveraging on the TARP money?

Joe --

I don't know that I can give you an exact number, Ben, but we -- we were fortunate that we entered the mortgage-backed market when the rates were pretty nice. And we were able to fund it when the funding curve was going the other way, match funded. So we have actually got a nice spread. I don't remember the exact numbers and I'm reluctant to say them. But to say that it was a timing -- was a timing issue and it worked out real well. Then it is better than we ever yet -- investments is accurate. But I don't know the exact number. I know I have it in my desk somewhere. But we got a nice spread.

And was that put on? I mean I'm trying to relate the timing of that to the fact that you had to accrue the preferred dividend, I guess for half the quarter. Were the assets on the books pretty much contemporaneously?

Yes.

Okay. All right. Great, thank you.

Sure.

Okay, thank you. And our next question comes from Jeff Honer with Kirkland & Ellis.

Yes, thanks for holding the call. It is a pretty interesting discussion. I have a question about the senior preferred stock with the investment by the government. At this point, the government seems to be using their investment in CITI Bank to force them to make some decisions that they probably wouldn't have made before. What is the -- what is the ability to discourage that investment if you chose to do so?

The investment -- the rules under the investment today are -- within the first three years if you want to replace the capital you have to raise like capital, basically Tier one capital. After three years you can pay it back. So the government put in a struck that said if you do it before 2009, you can also eliminate 50% of the warrants. So there are some opportunities to do to give it depending on what the markets give us and we obviously will pay attention to all of that.

All right, thanks.

Thank you, and once again ladies and gentlemen as a reminder if you would like to ask a question, please press star one. And our next question comes from Kenny James with Robert Baird.

Hi, (Inaudible) was that like a private label product or that is not some kind of structure product.

It is a private label.

And then on the credit trends, the last quarter, the consumer stuff has leveled well, are down but the charge-off keep going up, the commercial -- can you kind of give me some more color on why you're comfortable and don't think that is the front edge -- call it a wave. But deterioration in the asset class?

Based on our analysis of the portfolio as what we're seeing, and the fact that it was one loan. There could always be one loan the next quarter or the next quarter or two or three. But look there is going to be deterioration. I am not going to sit here and say that the economic conditions are not weakening. But when we sit and look at it, well -- Kenny, I guess that is why I'm saying that we're going to be in this range that we're now. That we're not certainly going to see things subside over the next quarter or two. But we don't see it expanding past what we're seeing now. So that net, as we go through each quarter, deteriorating loans, we're projecting are going to stay at a pace what we have been seeing, and not be another wave effect. And that is based on our best estimate of how we're analyzing these loans and really looking at them in great detail all the time. We are also going to be governed by the economy. And the economy is in the markets in which we serve. So on a relative basis, we're in areas where maybe they're a little more stable than other parts of the -- of the country. But if we see -- extended deeper recession kinds of factors, then those numbers would reflect that -- that weakness.

Okay. And just -- let me have another question on that if I look at the fourth quarter and I see construction being charged down in the fourth quarter, my first assumption would be that is going to be an anomaly. Would you agree or disagree with that?

I would agree that basically we saw an incredible ramp-up of residential construction, nonperforming loans and charge-offs here in 2008. And much of that was from a small segment of our portfolio that had some -- well, a little bit that was out of market and had some characteristics that drove it as real estate started to weaken early. We're through a lot of that, and I think we're going to continue to experience weakness in that sector. But I don't think we're going to see the sustained levels of deterioration that we saw earlier. Because much of that deterioration was unique to the rest of the portfolio. And we're coming more and more back to smaller, Wisconsin, Illinois, Minnesota-based customer relationships. And I think it's going to be more diverse, smaller credits and less, raw exposure to the weakness because of the nature of those companies and those businesses and where they are in our under writing. And the deterioration of the collateral itself is very different from what we saw in those early on experiences. So we're going to continue to see weakness and we're going to see deterioration for sure. But we're not going to see it at the sustained levels that we saw six months ago.

Okay, fair enough. And on the tax rate I think high 20s, is what you guys talked about before. Is that a safe assumption for the tax rate?

Low 30s, high --

And again Kenny, on the tax rate obviously at the margin for 35% for federal and 37% for state. So if we start getting ramping earnings up, it moves pretty high. But I think if you were in the 30 range, that would be a fair thing to think about.

Okay, thank you.

Okay, thank you. And our next question comes from K.C. Ambrecht with Millennium.

Hi, thank you very much for taking the questions, appreciate it. Could you guys say what your problem loans are? You guys always do a good job of disclosing that. Last quarter I think you had potential problem loans of around 7 million.

Potential problem?

Yes, potential problems.

Yes, we don't have that number gathered at this point, we'll get it as we get into the Q.

Well do you think it is up, slightly up, right?

Yes.

Okay. And then the -- the MPAs's look like they're going to be 390 million up from 350. And -- I'm just looking at the spread sheet from the press release. I have a bad printout, so I'm trying to double check the numbers while I have you guys on the phone. 389 versus 351 last year.

You're correct, that includes other real estate.

Okay, and your past dues right now, what are they?

Well, 90 days or more past due are on that sheet. And net -- 30-90 past due number is flat to last quarter, which if I remember correctly is around 90 or 190 million.

So last quarter guys, if you added up your problem loans, MPAs and past dues is around 1.2 billion or 7% of your loans. And -- so should we go to like 9% or 10%? Or are we -- you just don't have it yet.

I would be just speculating. We just don't have it.

So it will be available -- And you mentioned this one credit that you booked, C&I. Was this -- 20% of your C&I is out of footprint, right.

No, I don't think that is right.

How much of your loan book is that a footprint?

Total loan look is at 2 or 3%. The total loan book.

We don't have any portfolios that would approach any numbers near that. I would have to go back and check that, K.C. But it is not that high. I tell you what, give us a call, we can sit and look at the last analyst set and sit and walk you through that. In some of the businesses you'll see some loans that are at a foot print. But they're -- example if we're working with a drug store chain that is based my Minneapolis that has store s in 30 states, yes, we may have a drug store in -- pick a state.

Okay, I got you on that.

And the customer is here and it is just a physical presence in another location. That is a very different -- than saying gee you got out a market exposure to --

Okay, and then just one last question on the capital, a lot of people asked you about that. So right now you're paying out $0.32. And -- I guess -- can you just kind of go through that again, how you think about it? Because from our seat right now, it looks like your tangible common equity went down to around -- down about 10% -- at 5.86%.

No, it is at 6.05. Starts with a six -- 6 --

Because I'm calculating different.

It went down entirely because of the $1.7 billion. So he 1.7 billion, so the changed, we continued with tangible equity through the market valuations of our securities and our investments in average are above water and actually increased in value. And through a couple of other areas, we have 1.9 billion of tangible common equity, when we started the quarter, we got 1.9. When you ended the quarter, it is just that it is bigger company.

I guess this is my question and I'll leave it at that is definitely moving down --

We're a bigger company --

I guess my question is this.

Exactly the same, the dollar amount of tangible common equity is the same number from the end of the last quarter to the end of this quarter.

I guess this is my question, at best it looks that you guys can earn around $0.30. So at best you're earning 100 payout ratio. Could be higher if you book any more credits. Are you still comfortable with paying out that type of dividend?

Yes, if you look at our core earning, if I look at my retained earnings this quarter, it is above $0.30. I know isn't going to recur. It can always be a one-time thing. Next quarter it is a different one-time thing. But we're planning on earning in the -- the 30s. Not 30. And our retained earnings, our core earnings when you look at it reflect that. So that is how I'm looking at it. I can add it up for you, and everybody can disagree on what is core and what isn't. But you know the mortgage business is 5 or $6 million off its run rate. The mortgage applications the way they are. I look at the margin even down at a significantly lower percentage and it is going to be contributing at a greater dollar amount than it was last year. And expenses relatively flat. If credit can be in the ranges that I'm talking about our retained earnings are going to be just fine.

Okay, and just let us know if you want to send Brett Favre back to Wisconsin.

You can keep him.

Okay, thank you.

And ladies and gentlemen this does conclude our question and answer session for this conference. I would now like to turn the conference over the Paul Beideman for any closing statements.

No closing statements, thank you all for your participation. I appreciate it.

And ladies and gentlemen this does conclude our Associated Banc-Corp fourth quarter 2008 earnings conference call. If you would like to listen to a replay of today's conference please dial 800-406-7325- or 303-590-3030 with the pass code 3960724. Thank you for your participation and you may now disconnect.