Associated Banc-Corp (ASB) 2010 Q2 法說會逐字稿

Good afternoon, everyone. Welcome to the Associated Banc-Corp second quarter 2010 results conference call. My name is Joe, and I will be your operator today. (Operator instructions). During the course of the discussion today, Associated Management may make statements which constitute projections, expectations, beliefs or similar forward-looking statements. Associated's actual results could differ materially from the results anticipated or projected in any such forward-looking statements.

Additional detailed information concerning the important factors that could cause Associated's actual results to differ materially from the information discussed today is readily available on the SEC website in the risk factor section of Associated's most recent form 10K and any subsequent 10Q. Following today's presentation, instructions will be given for the Question & Answer session. If anyone needs assistance at any time during the conference, please press star then zero on your touch-tone phone. As a reminder this conference is being recorded. At this time, I would like to turn the conference over to your host, Phil Flynn, President and CEO, for opening remarks. Please go ahead, sir.

Thank you, Joe. And welcome to our second quarter conference call. Joining me today are Joe Selner, our CFO and Scott Hickey our Chief Credit Officer. This afternoon I'll provide more detail on our second quarter results and discuss the improvements in our credit quality, as well as our strong capital and liquidity positions. I'll also provide you with an update on steps we are taking to position the Company for future profitability and growth. Today we reported a net loss to common shareholders of $10 million or $0.06 per share for the second quarter. This compares to a net loss of $34 million or $0.20 a share last quarter, and $25 million or $0.19 a share for the second quarter of 2009.

We have taken a lot of actions to strengthen our balance sheet and aggress our credit quality during the past few quarters and we are seeing positive results. So let's start with credit. We saw a significant improvement in our key credit quality indicators during the quarter, including substantial declines in the loan loss provisions, net charge offs, nonperforming loans, potential problem loans and early stage delinquencies. The provision for loan losses for the quarter was $98 million, down significantly from $165 million for the first quarter and $395 million for the last quarter of 2009.

Net charge-offs for the quarter were $105 million, also significantly lower than $163 million for the first quarter, and $234 million for the last quarter of 2009. While we're pleased with declines in charge-offs over the last two quarters we expect them to continue at elevated levels as we continue to work through our nonperforming loans. Our allowance for loan losses was $568 million, or 4.5% of total loans for the quarter, up from $4.3 million-- I'm sorry, 4.3% in the last quarter.

Nonperforming loans were $1.02 billion at June 30, down $190 million or 16% from $1.21 billion at March 31. The decline in total nonperforming loans was primarily driven by the sale of select problem loans and the continued slowdown in the formation of new nonperforming loans during the quarter. Through a combination of bulk and individual loan sales, we sold over 70 notes with a total bank balance of $216 million during the quarter. We received an average of $0.73 against our bank balance. 57% of the $216 million in NPLs sold came out of the real estate construction segment portfolio with the balance, 43%, coming out of the commercial real estate segment. About half of the loans sold were for projects outside of our core markets with the balance split between Wisconsin and the combination of Minnesota and Illinois.

The flow of new nonperforming loans continued to decline. We had $169 million of new non-accruals in the second quarter, down 41% from $287 million in the first quarter and down 64% from $475 million in the fourth quarter of 2009. The nonperforming loan book was marked to approximately 67% at the end of the quarter. The marks ranged from a low of about 53% for the C&I portfolio to a high of approximately 78% for commercial real estate loans and about 65% for construction loans. Of the new additions to nonperforming loans approximately 47% are current. In total, 36% of our nonperformers are current.

The ratio of nonperforming loans to total loans declined to 8.09% at June 30 from 9.1% in the first quarter. We're confident that the ratio of nonperforming loans to total loans will continue to improve going forward. Our overall level of reserves to the loan portfolio remains conservative at 4.51%.

The coverage of nonperforming loans grew during the quarter to 56%, up eight percentage points from 48% at March 31. That number will continue to improve over the balance of the year as we continue to reduce nonperforming loans through loan sales, charge-offs and pay downs. We continue to target a reduction in nonperforming loans of $500 million during 2010. Potential problem loans of $1.3 billion for the quarter were down $95 million or 7% from $1.4 billion at the end of the first quarter.

Upgrades in payoffs coupled with a reduction in migration in the nonperforming loans had a positive impact on potential problem loans. This was our second consecutive quarter of declines in potential problem loans. Similarly we continue to see improvements in early stage delinquencies. Loans 30 to 89 days past due totalled $149 million at June 30, down 10% from $165 million at March 31 and down 29% from $241 million at the end of the year.

This is the lowest level of early stage delinquencies we have seen since the third quarter of 2007. We believe we have seen the peak in nonperforming assets and that they will continue on a downward trend going forward. Given our significant reserve levels and these positive trends, we believe it is likely we will provide at a level that is lower than charge-offs going forward. As we forecast at the beginning of the year, we expect positive net earnings during the next two quarters. Our Company's capital ratios remain very strong. At June 30, the tangible common equity ratio was 7.88%. Our Tier 1 capital to risk weighted assets ratio was 17.25%. And the total capital to risk weighted assets ratio was over 19%.

As we have discussed previously we took steps during the first half of the year to strengthen our liquidity position to make sure that we have access to liquidity as needed as we work through this credit cycle. Today, with $2.5 billion in cash and cash equivalents and the ability to borrow against our securities portfolio, we have more than ample liquidity. We understand and we recognize the impact our current liquidity position has on our net interest margin and while we'll be redeploying this liquidity in the future to fund loan growth we believe that in this environment maintaining a very liquid balance sheet is the prudent thing to do.

Now I'd like to talk about some of the actions we have been taking for future profitability and growth. We significantly expanded our commercial banking presence in Chicago with the addition of a seasoned commercial banking manager who began building out her team with the addition of nine other experienced commercial bankers during the quarter. These bankers know the Chicago market, and our mid market clients and prospects well. We continue to believe there's a real opportunity for us to take advantage of the turmoil and disruption in the commercial banking space in Chicago and we expect to see signs of this team's activities during the next few quarters. Likewise, we added another 12 experienced commercial bankers in our other major markets across the footprint during the quarter.

We are also putting together a group of industry experts who will focus on targeted niches where we believe we have the potential to grow. In addition, we continue to build out our wealth management business which is performing well. We added two new private banking managers and five private bankers during the quarter, and we expect to add more in targeted markets during the next few quarters. We believe these types of investments and people will serve the Company well as the economy recovers.

As we have talked about before we recognize the need to reassess our credit rules and underwriting policies so that our relationship managers in the field can more competently sell the bank to our customers and prospects. We made significant strides toward more clearly defining the Company's acceptable risk appetite during the quarter, and we have put together the framework of our new credit policy and guidelines including recommended risk tolerances for certain asset classes as we move forward. We believe our investments in new relationship capabilities and credit processes will position us to capitalize on opportunities for loan growth.

Now I'd like to turn some select balance sheet and income statement items. As planned, we continue to trim our loan book during the quarter to better match our desired risk profile. Consequently the Company's loan portfolio was $12.6 billion at June 30, down 5% from $13.3 billion at March 31 and down 18% from a year ago. We saw declines in all segments of the portfolio during the quarter with the greatest declines focused on the real estate construction segment of the portfolio. At quarter end, construction exposure was $926 million, just 7% of the total portfolio.

This is down $356 million or 28% from the previous quarter. On a year over year basis, the construction segment was down $1 billion or 53% from $1.9 billion a year ago. The commercial real estate segment at $3.6 billion represents 28% of the total loan portfolio. This segment decreased by $122 million from the prior quarter and is down $161 million from $3.7 billion a year ago. At $3 billion the C&I segment of the portfolio was down $135 million from the first quarter, at June 30 this segment is 25% of the total loan portfolio. And while it's down from prior periods we continue to actively pursue new C&I business.

The consumer portion of the portfolio remains relatively stable. We saw a $61million decline in residential mortgages from the first quarter. And that's down $250 million from the same quarter a year ago. The home equity and the other consumer loan segments of the portfolio were relatively flat when compared to the prior quarter and the previous year.

Given our credit experience we view this as a very attractive business within our Midwestern markets. While loan demand continues to be soft across all the markets, we remain focused on our relationship-based approach to serving our clients, building out our lending infrastructure and pursuing growth opportunities in all of the target markets. Total deposits on the other hand grew to $17 billion at quarter end, up from $16.7 billion at December 31 and up from $16.3 billion a year ago. On a year over year basis, we saw increases in all deposit categories with the exception of brokered CDs and other time deposits which were down 39% and 19% respectively from the same quarter last year. Net interest income for the second quarter was $160 million, down $9 million from the first quarter of 2010 and down $19 million for the same quarter a year ago.

The decline from the previous quarter was primarily due to the declines in loans and long-term investments. Our net interest margin was 322 basis points for the second quarter of 2010, compared to 335 for the first quarter and 340 a year ago. Our net interest margin continues to be impacted by our liquidity position which accounts for about nine basis points of the reduction during the quarter, as well as our ongoing efforts to reduce risk in the loan book.

Core fee-based revenue remained relatively strong at $64 million for the second quarter. That compares to $62 million for first quarter and $65 million a year ago. On a linked quarter basis we saw a 10% increase in card fees, 2% increase in service charge fees. Trust fees for the quarter were up 2% and up 11% from a year ago.

It's too early to tell what impact the regulatory mandated changes related to debit card fees will actually have on our business. We did however begin capturing our customers' preferences during the second quarter regarding overdraft services. Customer response has been very good, and to date nearly half of those who have responded have chosen to opt in to our debit card overdraft service. While we continue to believe that we have about a $15 million risk of fee reduction during the second half of 2010, we expect to offset some of those potential losses with repricing strategies and the introduction of additional new checking products.

Mortgage loans originated for sale during the second quarter totaled just over $500 million, compared to $455 million for first quarter, and a record $1.3 billion for the second quarter last year. As you know, mortgage lending has slowed industry wide. The Mortgage Bankers Association reported purchase application rates nationwide were at a 13-year low in July, but refinance applications, however, are on the rise with rates sitting at 50-year lows.

Net mortgage banking income at $5 million for the quarter was basically flat compared to the prior quarter as we return to more normal loan origination levels from the historically high levels of last year. Total non-interest expense for the quarter was $155 million compared to $152 million for the first quarter and $170 million for the second quarter last year. Non-interest expense was down from the same quarter last year, largely due to the one-time FDIC special assessment and significantly higher foreclosure costs in that quarter. However, we expect foreclosure and OREO expenses will remain elevated at current levels for the next several quarters.

Turning to a couple of other subjects, regarding the repayment of TARP, this continues to be a priority for us, and our goal is to repay it as soon as possible. It's however more likely that repayment is going to occur in 2011 than this year.

And finally, on the topic of regulatory reform, we believe there are a number of positive aspects in the legislation including systemic risk oversight and resolution authority, and we also appreciate the fact that the new rules and regulations are intended to protect consumers in the US financial system. However, we share the concerns of others in the industry regarding the challenges and uncertainties that we will all face as the new rules are interpreted and implemented. We really can't comment at this time on how these changes will impact our businesses and our clients. We'll be better prepared to talk about that and the effect it will have on our Company as the rules are interpreted over time.

So that completes my prepared remarks. Now we'll open it up to your questions.

Thank you, sir. (Operator instructions). Our first question comes from David George from Baird.

Good afternoon and thanks for taking the question. A couple of things, on the NPAs that you sold during the quarter, how would you characterise these relative to the other NPAs that you're looking to dump over time? Was this kind of the best, average, worst? How would you characterize the stuff that you sold relative to the rest of the NPAs that you're looking to move? And then I have one other question as a follow-up.

Sure, David. So thanks. Our strategy on reducing the NPAs was to first of all take a look at the best course of action for the bank as we looked at these troubled loans. So loans that we think we can work out and do better on economically we will take that course. Loans that we think we're better off selling and taking our lumps now we'll do that. Generally speaking, we focused on selling the most distressed assets in this first pool. And are hopeful as we reduce the NPAs we'll be in a position to hang on to some of the stuff that we think is going to recover and maximize our return on those later.

Okay. And then finally, on your liquidity, can you talk about your strategies to deploy that over time and I trust that your liquidity is still kind of related to your ratings from the rating agencies. Do you have any update as to when you think the credit ratings would be revisited from the agencies?

Yes. So I can't guess as to when the rating agencies, one in particular, are going to adjust our ratings upwards. We are spending a lot of time with all the agencies including visiting them quarterly to make sure they understand our story. And hopefully, that will bear fruit pretty soon because I think clearly the Company is on the mend. As far as the liquidity position, I would grant that it is conservative, and we are looking at our liquidity position frequently. Likely as the economy improves and with the positioning we're doing to take advantage of growth that will come, the liquidity position will be used to fund new loans. That would be our hope.

Okay. Appreciate it. Thank you.

Our next question comes from Jon Arfstrom with RBC Capital Markets.

Thank you, good afternoon guys.

Hi, Jon.

Just a question on -- follow-up on Dave's question on some of the bids that you are seeing in the marketplace. Just curious on how deep that market is and if you have seen bids firm over the last couple of quarters?

Yes, you know, Jon, I get that question quite a bit and it's-- I find it very difficult to generalize about the distressed loan sale market because all of these loans have their own particular circumstances. We found during the quarter that those loans that we put forward for sale we got sold. I think the market from everything I hear is fairly broad, there's quite a bit of interest in buying distressed bank loans. And frankly at an average of $0.73 of what we have written the loans down to, we were reasonably pleased with that price. So we as you know intend on continuing to sell loans both in bulk and individually. And we're pretty confident that we're going to be able to achieve the results that we have talked about. We believe that we're going to get a significant amount of these NPAs down over the next six months and we're going to be able to do that and actually become profitable.

Then just a question on your coverage, your reserve coverage ratio. Where would you like to have that ultimately and how long does it take you to get to that target you're looking for?

Well there's the coverage of the NPLs which at 8% is still nothing to pat ourselves on the back over, although it's a significant improvement in one quarter. That number needs to come down quite a bit. Certainly to half of that over a reasonable period of time. Our overall level of reserves against the loan book is pretty high right now. That will come down over time, and some of these ratios are being frankly exacerbated by the fact that the loan book has been shrinking, so the denominator has been shrinking along the way.

One question maybe on a little more offensive. What's possible for some of the targeted niches, some of those businesses you're looking to enter? I think you put this group in Milwaukee, but give us an idea of what you think is possible for that and some of the near term and longer term opportunities?

Yes, I believe that industry focused groups at regional banks are a real winner. I came from a bank that essentially became a bank of niches. So areas such as healthcare, insurance and others that we're looking at, by hiring industry experts and expanding your reach beyond just the natural three-state footprint that we operate branches in. With a prudent measured growth in those businesses can become a real winner for a regional bank. So it's very early days. But I have experience with seeing these things be built out to be significant contributors, but we're talking in quarters and years, not in the short run.

How significant was it at UB?

Extremely significant. The specialty lending areas were as profitable or more profitable than the core commercial bank.

Thanks.

Our next question comes from Scott Siefers from Sandler O'Neill.

Afternoon, guys. I guess I wanted to just ask another question on the loan sales. Just want to make sure that I understand it correctly. So you ended up basically taking a 25% hair cut on loans that had already been marked down, so I think one of the investor hopes was that the loans pool that you were going to potentially sell was already marked down sufficiently such that there wouldn't be additional charges. Now, going forward, would you anticipate additional haircuts or it sounds like you said-- you're selling the most, or you sold the most distressed stuff first. The reason why I ask is there's the sense that you're taking additional haircuts on stuff that was already marked down, a logical question is what does that say about the marks on the stuff that's already there? Maybe you can just kind of expand on that topic.

Sure. Bank accounting doesn't allow us to mark our entire NPA book down to what we think is a market clearing price. I mean, that's not what we can do. We have to mark them down according to the rules we live with. A new buyer of that loan is going to expect a return when they buy the loan. So I think it's very unlikely on average that you're going to sell distressed loans in the secondary market without some sort of further haircut. And if I at some point gave you or anyone else the impression that was the case I certainly didn't mean to. We have always anticipated that there would be some further loss or charge as we sell loans into the secondary market. The trick to this of course is to make sure that our reserve is more than adequate to handle that. I mean, theoretically if we had the entire nonperforming loan book marked to clear the secondary market we wouldn't be carrying around a reserve, which of course isn't the case. So we have a very significant loan reserve -- loan loss reserve up against our entire loan book, particularly the nonperforming loans which allow us to continue to sell these, move down our NPAs and do it within the core earnings that we expect within the Company.

Okay. That's helpful. Thanks. And then if I can ask just a separate follow-up question just on the margin, assuming we don't get a rebound in loan demand in the near term, what's your sense for how much additional erosion is possible from where we are currently?

Our best estimate right now is it's going to be about flat from here.

Okay. Okay. Great, thank you very much.

Our next question comes from Terry McEvoy from Oppenheimer.

Thanks. Good afternoon. I guess the first question, Associated gets quietly operated in the Chicago market and now you're looking to add scale. What have you run into in terms of clients' perception if anything of Associated Bank, and is there a going to be kind of a branding initiative where there's some upfront costs involved with getting that new group up and running?

That's a great question. Associated has been active in Chicago for a long time. We have a relative handful of retail branches and locations there. So no one would accuse us of being a household name in the Chicago retail marketplace. Commercial banking is a little different. We have hired some well known experienced bankers in Chicago. We can support them not with, for example, a broad-based TV advertising campaign or something, but with targeted print, with event-driven marketing efforts, and just with the general knowledge that the business community has of the folks that we're hiring down there. So we think we can make a difference for ourselves in the commercial banking space. You're absolutely right, if we at some point choose to expand in retail, in order to really be successful there it would require significant outlay in marketing dollars to be noticed in a market as big as Chicago.

Then just the second question, we've never really heard much at all from Associated on wealth management or private banking, and you did mention that earlier. I guess in simple terms, what do you have now? And what are you looking to add to those two or maybe one business?

That's a great observation, Terry. You know, one of the things I was struck by when I came here six months ago was we have a very nice wealth management offering. We have a robust trust area, we have an asset management division that performs very well, outperforms most of the peers in this part of the world. What we haven't had is enough distribution in my opinion to really sell those products. That's why we have been hiring private bankers on the relationship management side, so we can grow that business through an expanded distribution effort.

Thanks.

Our next question comes from Erika Penala from UBS.

Good afternoon. My first question is a clarification question. You mentioned that about 40% of the $216 in NPLs sold came out of non-construction commercial real estate.

Right.

If I add that back in, in the NPL totals for the quarter, it seems like the NPLs moved notably sequentially. I was just wondering if you can give us a sense of what type of asset classes or geographies pushed commercial real estate NPLs higher?

Commercial real estate NPLs did not go higher during the quarter.

I'm sorry, I must be -- commercial -- I'm looking at non-construction, $360.9 million versus $356.8 million a quarter ago.

Okay, so it went up less than $4 million.

No, I guess I was adding back the $85 or so million that you sold. Out of that bucket.

Okay.

So I was wondering, what the new inflows were in that particular category.

Well, we had total inflows of new non-accruals of $169 million. Last quarter, we had total inflows across all asset classes of $287 million and the quarter before that $475 million. Okay? So we've gone from $475 million of inflows to $287 million to $169 million. I don't have in front of me what that $169 million is, but half of it or even more could well be commercial real estate assets. However, the trend of new nonperforming asset creation is dramatically down.

Okay. And I just wanted to ask a follow-up question. You mentioned the geographic breakout of the loans -- the NPLs that you sold. I was wondering if you could give us the geographic breakout of the term commercial real estate and construction loans you have remaining on NPL.

I may have that, but I'm not sure. Hang on a minute. You know what I would recommend, these are such detailed questions why don't you call Joe and he can give that to you.

Sure. Thanks for taking my call.

Sure.

(Operator Instructions.) Our next question is from David Konrad from Keefe, Bruyette & Woods.

Good afternoon. During the quarter, asset quality and credit costs improved materially but pre-tax revision earnings kind of slipped a little bit from the prior quarter. You talked about margin outlook and liquidity there. But kind of a follow-up from Terry's question, expenses were up quite a bit linked quarter. I just wonder with all the initiatives for growth in the future, what should we see from the expense line and total over the next few quarters?

First of all, expenses were up $4 million. They went up dramatically on only a quarter basis. Also recall that we had a significant security gain in the first quarter. So core earnings slipped with the reduction in loans. But I think it's kind of in line with what we have been expecting. Joe do you have -- go ahead.

Again, the increase in the quarter was related to legal and professional fees and foreclosure expenses and those have a little bit of variability in it. So the rest of the expenses were pretty well controlled. So I think that $3 million is really relating to those categories, and so the rest of the expenses should be well controlled even though we're investing in people as Phil has said.

Okay.

We don't expect it to move much from where it is.

But at the end of the day you're correct. I mean, certainly the pre-provision earnings of the Company have been under pressure with the very substantial reduction in loan outstandings. There's no sugar coating that. And the efforts that we're making now with adding people and building out some of our capabilities in places like Chicago are designed to take advantage of potential growth when we can see it.

Yes, the way we think about it is net interest income was down $9 million. Fee income, if you take out that gain, was up $7 million. And expenses were up $3 million to $4 million. So again, most of the change is going to be the net interest income in the pre-tax provision.

Okay, thank you.

I'm showing no further questions on the phone. I'll now turn the conference back to Mr. Flynn.

Well, thank you for joining us today on the call. In closing, we're very pleased with our progress to date on resolving our credit issues. A lot of work remains but we're confident that the credit profile is going to continue to improve through the rest of the year. Likewise, the actions we're taking to bring in new and talented bankers across the franchise and the efforts we're making to define our risk appetite and streamline the credit approval process are going to bear fruit for us in the form of profitable loan growth in the future as the economy improves. So thanks for taking the time to join us today on the call. And if you have any additional questions, please feel free to call us and thanks again for your interest in Associated.

Ladies and gentlemen, this concludes the Associated Banc-Corp second quarter 2010 conference call. If you'd like to listen to a replay of today's conference, please dial 1-800-642-1687, for international participants 1-706-645-9291, and enter in the access code 85356495 followed by the pound sign. The replay will be available until August 22, 2010. Thank you for your participation. You may now disconnect.