Associated Banc-Corp (ASB) 2010 Q3 法說會逐字稿

Good afternoon, everyone. Welcome to Associated Banc-Corp 's third quarter 2010 conference earnings call. My name is Joe, and I will be your operator today. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session at the end of this conference. Instructions will be given for the question-and-answer session following the presentation. (Operator Instructions).

Management will be referencing a slide presentation during the prepared remarks. A copy of this slide presentation, as well as the earnings release and financial tables, are available at the Investor Relations portion of the Company's website at www.associatedbank.com.

During the course of the discussion today, Associated management may make statements that 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 statement. Additional detailed information concerning the important factors that could cause Associated's could differ materially from the information discussed is readily available on the SEC 's website in the Risk Factors section of Associated's most recent Form 10-K and any subsequent Form 10-Q. Now I would like to turn the call over to Phil Flynn, President and CEO of Associated Banc-Corp.

Thank s, Joe, and good afternoon, everyone. Joe Selner, our CFO, and Scott Hickey, our Chief Credit Officer, are with us today. I will begin by talking some of our highlights for our third quarter and then provide a credit overview and more detail about our quarterly financial results. Finally I will provide some updates on our business activities, and then we'll be happy to answer your questions.

As outlined on slide three of the presentation, today we reported net income to common shareholders of $6.9 million or $0.04 per share for the third quarter. We believe we've turned the corner on profitability and we're encouraged by the growth we saw in commercial loans and our commercial loan pipeline during the quarter. Consumer loans also grew during the quarter, with mortgage loan activity up significantly and home equity loans showing positive growth for the first time since the fourth quarter of 2008.

We continue to see significant improvements in our credit metrics and continued slowdowns in the inflows of new problem loans. Potential problem loans were down 11% from the prior quarter, and 30 to 89 day past-due loans were down 16% from the second quarter. Both declined for the third consecutive quarter. We continue to aggressively work on reducing our problem loans through [robust] internal management and loan sales. nonperforming loans were down 20% from the prior quarter. As previously stated, we have expected to sell a total of $500 million or more of nonperforming loans during the year. We are well on our way of achieving that goal, with total nonperforming loan sales of $434 million through the end of the third quarter, including $199 million in the third quarter.

Net interest income was $154 million for the quarter compared to $160 million for the second quarter and $179 million for the same quarter a year ago, as reductions in borrowings and deposit pricing did not offset declining loan income. The Company 's tier 1 capital and total capital to risk-weighted ratios were 17.68% and 19.1% respectively at the end of the quarter,which we believe are among the strongest in our peer group.

Now I will get into more detail about our third quarter results, and I'll begin with the loan sales. The charts on slides four and five provide more detailed information about the nonperforming loans we sold during the quarter and year to date. Through the combination of bulk and individual loan sales we sold more than 300 notes during the quarter. On average we received $0.71 against the net bank balance,the balance on our books minus the FAS 114 reserves we held against the specific loans sold. The net proceeds from these sales were roughly comparable to the proceeds received from our second quarter loan sales. The loan sales are part of our strategy to reduce our level of nonperforming loans. We plan to continue our sales efforts through the balance of the year, and we expect sales of nonperforming loans in the fourth quarter will be approximately $100 million.

Slide six shows the slowing inflow of new nonperforming loans. With $100 million of new nonaccrual loans during the quarter, we had the lowest formation of net new nonperforming loans that we have had in six quarters. With the sale of nonperforming loans and this downward trend in new NPLs, total nonperforming loans of $817 million are significantly lower than where they peaked in the first quarter. We expect this trend will continue into the fourth quarter. The nonperforming loan book was marked to approximately $0.67 at the end of the quarter. The marks range from a low of about $0.52 for C&I loans to a high of about $0.77 for commercial real estate loans, and about $0.63 for construction loans.

Slide seven gives you a snapshot of the significant improvements we've made in our credit metrics during the past four quarters. The ratio of nonperforming loans to total loans was 6.6% at September 30, down from 8.1% in June 30 and 9.1% at the end of the first quarter. Our overall level of reserves to the loan portfolio remain strong at 4.2% at the end the quarter,and the coverage of nonperforming loans increased to 64% compared to 56% at June 30.

On slide eight you will see the potential problem loans declined to $1.1 million. Importantly, when you look loans downgraded to nonperforming status, that number has come down steadily since the end of 2009. Slide nine also shows the downward trend in loans 30 to 89 days past due. At $124 million, loans past due were down $25 million or 16% from $149 million from the prior quarter, and down $117 million from $241 million at the end of 2009.

If you go to slide ten, you will see the key drivers of our lower provision of the quarter. Net charge-offs of $110 million included $89 million in charge-offs related to the load sales. $40 million of FAS 114 reserves specifically related to the loan sales were released during the quarter, and we booked an additional $12 million in reserves for other remaining FAS 114 loans. Historical FAS 5 loss allocations decreased due to lower loan balances and slower credit rating deterioration and migration of loans into nonperforming status. As mention earlier, our overall level of reserves to the loan portfolio was very strong at 422 basis points.

I will just touch on slide 11. At September 30 our tangible common equity ratio was 8.03%, up 15 basis point from 7.88% at the end of the second quarter. Our tier 1 capital to risk-weighted assets ratio was 17.68%, up 43 basis points from the prior quarter, and our total capital to risk-weighted assets ratio increased by 14 basis points to 19.6%.

Let me move to some select balance sheet and income statement items. Slide 12 provides a snapshot of our loan portfolio at September 30. The Company 's loan portfolio totaled $12.4 billion at the end of the quarter, down $230 million or 1.8% from $12.6 billionat the end of the prior quarter, and down 16% from a year ago. As we indicated last quarter, we expect our loan portfolio to be down about $4 billion from its peak at the end of 2008. But it's important to note that the pace of decline in the loan portfolio has slowed quite a bit from the second to the third quarter.

Consistent with our general strategy of rebalancing the loan book, the greatest decline was in the construction segment of the portfolio, which as $736 million was down the 21% from the prior quarter and down 54% from $1.6 billion a year ago. The construction portion of the portfolio represents only 6% of our loan portfolio now, at September 30.

At $3.5 billion, the commercial real estate segment represented 28% of the total loan portfolio, which is down 2% from the second quarter and about 10% from a year ago.

We were very pleased to see net growth in our general commercial lending portfolio. At quarter end, the C&I segment at $3 billion was 25% of the total booked. We expect to grow the segment going into 2011.

We also saw a pickup in both residential mortgage and home equity loan balances during the quarter. And going forward, as we have discussed previously, we expect to remain more of our in-footprint 15 year production.

Total deposits were $16.8 billion at quarter end, down slightly from 16.9 billion at the end of the second quarter and up 2% a year ago. Year over year, demand deposits and savings balances were up modestly, while brokered CDs, other time deposits were down $800 million from a year ago. And in addition, network transaction deposits, which include brokered and institutional money market funds, were down over $700 million from the quarter.

As I mentioned earlier, margins came under pressure during the quarter. While we expected the margins to trend over in Q3 and then recover in 2011, the downturn was more significant than we expected. This was in part due to the generally lower level of rates in the markets than we expected, continued loan runoff, and the impact of our decision to hold a strong liquidity position.

Referring to slide 13, net interest income was $154 million for the quarter, down $160 million for the second quarter and down $25 million from $179 million for the same quarter a year ago. On a sequential quarter basis most of the shortfall came from reduced load interest income, our strong liquidity position, and reduced yields on our investment portfolio, which is relatively short-term in nature. The Company's net interest margin was 308 basis points for the quarter, which was down 14 basis points from the prior quarter.

Given a stable rate environment, we believe we can improve the Company's net interest margin over time. We'll be investing our excess liquidity during the fourth quarter and expect to realize further positive impacts from managing down to deposit pricing. Based on the current competitive environment in our markets, we believe we can reduce the deposit rates without significant risk of running off deposits.

Non-interest income for the quarter was $82 million, with relative relatively strong third quarter fee-based revenue of $61 million. Driven by the current wave of refinancing activity, net mortgage banking income of $9 million was up significantly from $5 million from the second quarter, and basedon current trends we expect these dynamics to continue into the fourth quarter.

Third quarter mortgage banking results included a $9 million valuation charge related to mortgage servicing rights. Service charges on deposit accounts of $24 million were down 10% from $26 million in the quarter and down 23% from the same quarter last year. This reduction was primarily driven by our Reg E Opt-in experience, overdraft policy changes, and changes in customer behavior from the prior year. Last quarter, we said we believed that we had about a $15 million risk of fee reduction during the second half of 2010, and our results today suggest we'll retain a little less than half of that amount.

Regarding the Durbin amendment, the impact on fee revenue will be influenced by the actual interchange turns; however, we believe based on what we know today, approximately $4 million in fees may be at risk in 2011, given that the amendment doesn't going into effect until the second half of the year. Non-interest expenses continue to be well controlled, with increases in legal and professional fees partially offset by a $1.6 million decrease in foreclosure and OREO expense.

Let meet move on to a few highlights from our business segments on slide 14, beginning with retail banking. The low rate environment has created another wave of mortgage refi activity. We current have about $1 billion in commitments in the pipeline, which will have a positive impact on net mortgage banking income in the fourth quarter and contribute to our net loan growth going forward.

We introduced a new line of our checking products during the quarter. While we experienced some runoff with the introduction of the new products, production has slowly improved over the course of the last three months. However, average balances on the new accounts are very strong. Average balances on new accounts opened in August were 21% higher than a year ago.

I would like to address the foreclosure process issue. We process our own foreclosure work, and we maintain the original files and documents in the house. Affidavits are reviewed and completed internally as well as externally by counsel. We have internal processes and procedures in place to ensure that each foreclosure is validated and processed correctly.

As I mentioned earlier, we continue to see in increased activity in our commercial banking business. This was the first quarter of average and period-end growth in the C&I segment of our portfolio since more than a year ago, and we're now in the fourth month of increasing pipeline in the commercial banking business. Commercial loan production during the third quarter was up significantly from the previous quarter. We saw the biggest gains quarter over quarter in Wisconsin and in our Southern region, which includes Chicago. The pipeline for Chicago has increased significantly during the past 45 days as we begin to realize the benefits of the investments in people we've made there.

We saw an increase in small business applications, and as a result, strong pipeline growth during the quarter. This was due in large part to steps we've taken to increase our focus on small business by leveraging our branch distribution network. Associated Banc finished the fiscal year ended September 30 as the number one SBA lender in Wisconsin for the six the consecutive year, and we expect production in the final quarter of 2010 will grow as a result of extended SBA benefits included in the Small Business Job Acts of 2010.

Deposit account balances were up from the previous quarter as our commercial banking customers continue to focus on liquidity and held on to their excess cash. This was the best quarter since early 2008 for commercial banking fee businesses driven by the implementation of our online foreign exchange system and concerted cross-sell efforts between the business lines.

During the past few months we've made significant strides toward more clearly defining our strategies for commercial real estate lending. We recently hired Breck Hanson to head up our commercial real estate business. He will be reporting directly to me. Breck brings more than 30 years of banking experience and a keen understanding of the Midwest real estate markets to our Company.

Trust assets were $5.4 billion at September 30, up 3%, $5.2 billion a year ago. Third-quarter trust fees were 4.5% from the same quarter last year, and year to date they are up to about 9%. As I mentioned last quarter, we continue to build our distribution system with the addition of seasoned, experienced private bankers. Deposits are growing nicely as these new bankers bring on new business.

So in summary, a little less than a year ago, we laid out a plan to return Associated to profitability. We recognized our problem loans in 2009 and took the appropriate actions regarding loan loss provisions and nonaccrual recognition. We ensured a strong capital base and liquidity. We laid the ground work for resolving the high levels of nonaccruals during the first quarter and have executed significant loan sales resulting in much better credit picture for us today. improve.

While we have continued work in front of us, we are highly confident that our credit results will continue to improve. We're seeing good signs of loan growth, and it islikely we'll see net growth during the fourth quarter. All in all we're increasingly well positioned for the future. So that completes my prepared marks, and now we would be happy to take your questions.

Ladies and gentlemen, we will now begin the question-and-answer session. (Operator Instructions). You our first question comes from David George with Baird.

Good afternoon. Thanks for the question. A couple of things. Can you clarify, Phil, your comment on the margin? Did you kind of say that it -- imply that it bottomed and is going to start to trend higher? And then I had a followup.

Yes, we believe that, absent another general deterioration is in rates, that this is probably the bottom. We would acknowledge the fact that we missed the decline from the second to the third quarter. But as best we can tell now, this should be the bottom, and it should creep up a little bit in the fourth quarter.

Okay. And a related question. You're kind of -- your liquidity position is meaningful at a little over $2.2 billion, $2.3 billion. It's over 10% of your asset basis. Do you expect that liquidity to start to come down over the next couple of quarters? Like how big is that going to get do you expect?

We've actually been working hard to deploy that liquidity even during this past quarter and have reinvested into mortgage backs and such. Short-term mortgage backs. But we've also been overrun with cash flows coming in from refis on mortgages as well as prepayments on securities. So we are planning to run that liquidity position down quite a bit during the fourth quarter, and infact we've already taken some pretty big strides in that.

Okay. That's helpful. Appreciate it.

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

Good afternoon.

Hi, Jon.

A couple of questions here. How would you describe the quality of the problem assets that you have left to sell compared to what you divested of in Q3 and Q2?

Generally, I think we laid out a plan for everybody that we were going to sell what we deem to be the worst stuff first, and that we would generally hang onto things that we thought would improve later. So we -- our intent here is to be pretty much done with these bulk loan sales by the end of the year. As I mentioned, we'd sell maybe about $100 million this quarter. And after that, loan sales would become part of the more normal work-out process as we evaluate credits one by one.

Okay. And what do you think is the right level of nonperformers for a bank this size? I mean, if we're at 750 to 775 by the end of the year, where do you think you need to be in the long-term for it to be acceptable to you?

Well, we still have work to do here. Where we're at today shows really good progress, and we're happy with it, butwe still have a ways to go. Our nonaccruals ultimately, as we get further into the economic recovery, are going to be a lot lower. We have a lot of situations that we're working on now which are resolve toward loans going back to accrual. Certainly, we have got to be below 5% and probably well below 5% as we get further into next year, but typically --you've seen the cycles. Typically the nonaccrual book will get low as we get into better economic times.

Okay, and then just one little different question. What are you seeing in terms of Illinois lending health? I noticed it was a big piece of our loan sales this quarter, but you are also growing in that market. And I guess -- some have said it's a lousy market to be in if you already have exposure, but a good market to enter if you don't have exposure? Can you give us an idea of your thoughts on that?

I think that sounds like a pretty correct statement. The stuff that we had, the legacy stuff, we're selling pretty rapidly, and you saw that. But, frankly, for a bank that's very well capitalized, very liquid. and rapidly improving its credit posture with the very seasoned bankers we've hired in Chicago, we're pretty happy with our position there right now.

Okay. Thanks.

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

Good afternoon, guys. I was just hoping you could extend a little on the additional charges you took on the loans that were sold. It looked like last quarter it was around 25% haircut or so. This time it was closer to $0.40 or so. If you can just kind of expand on your thoughts there. And then just given that you have been active throughout the year in the second market for problem assets, any top level color you could give on what you are seeing overall on the pricing liquidity in the secondary market would be helpful.

Sure. We tend to think about our loan sales as what we've taken as charges already, what charge-offs we have to take to clear the market, and then offsetting that are the specific reserves that are tied to the specific loans we are selling. So you're absolutely right, the charge-offs were higher, butwe also had $40 million of FAS 114 specifically attached to those loans which we released. So when you net that back actually the market for the loans we sold in the third quarter versus the second quarter was right about the same.

Okay.

As a general statement about the market, it's liquid. There are buyers. I don't think there's a lot of distinguishing credit quality on notes that are being sold into the distressed market. So we might think a loan as maybe better than another loan. The market is send tending to price things as asset classes pretty similar in our experience, so -- Yes, we've been active, we're only a little tiny part of the distressed market, but that's been our observation.

Great. Thank you very much.

Our next question is from Ken Zerbe from Morgan Stanley.

Great, thanks. You made a comment that you expect $4 million in fees to go away, related to Durbin, in 2011, which is a partial year. What assumptions are you making about how much of your expenses -- or how much of your revenues go away, and if there's any expense offsets to that?

How much of our revenues on interchange fees?

Yes, like what percentage is that? And -- but does that also take into account any expense benefit you may get, if there is any? (Inaudible -- multiple speakers).

Yes, Ken, there's no expense benefit. We think that's a partial year. We're probably anticipating roughly a third, 40% potentially could go away.

Okay.

And we'll -- we've rolled out new bundled value-driven checking products, which require -- in exchange for various things that we're willing to bundle together, people have to keep a certain level of balance or they are gonna have to pay fees. And that will help offset, but the whole industry is facing a pretty big change on this interchanges, as you know.

Of course. And then just in terms of commercial loan growth, you talked about finally seeing some stabilization, maybe a little bit of improvement on that. Maybe just describe that a little bit more. Is this a broader in terms of just more activity in the commercial space? Are you gaining share in a stagnant market? Are you competing on price to get that loan growth? Any color would be great.

Sure. I wouldn't say that, as a general statement, commercial loan growth is picking up for the industry or for the region. Very honestly, as I've talked about in the past, Associated was not doing a good job of looking for new business and working with our customers in the commercial banking space, given its issues of a year ago to two years ago. We've put a lot of focus of being back in the market, supporting our customers, getting our underwriting and credits approval lined up together, and we're starting to see the results of that, along with the fact that we've hired a number of very seasoned folks in the market which they are active in. So I'm very encouraged about what we see for Associated Bank, but it's mostly about what we're doing to get our own act together, if you will, versus some general economic pick up out there. Yes, I would say we are probably taking a little bit of market share more than participating in a big recovery.

Okay. Perfect. Thanks.

Our next question comes from Terry McEvoy at Oppenheimer.

Hi, good afternoon. Just looking at your expenses. They're up, call it $5 million in the third quarter versus the first quarter. And my question is, as you look out into 2011 at some of the initiatives that I assume you have in place. What do you think expenses will do? Do you think it'll maintain that quarterly run rate were it is now, or is there a potential for expenses to go higher as you really invest in the franchise?

Yes, Terry, we'renot prepared to get into 2011 guidance. We'll do the best we can in January. It's true that we are making some investments in things that we have to make investments in here, but I think, as I've said, wedon't expect to see our expenses run out of sight. This is a very efficient organization. It always has been, and we'll do the very best we can to keep it that way.

I know Jon asked earlier about Illinois. Could you just comment? How large would your Chicago condos slash housing exposure be at this point do you think from, call it the legacy portfolio?

It's a lot less, because we sold a lot of that in this last quarter. I don't know exactly what it is, but it's getting to be pretty small.

And just a last question. You made comments about recently about being a larger commercial lender in the state of Wisconsin. Do you expect that to come from hiring, further penetration in some of the larger markets where you just don't have as large of an exposure? Just some comments behind that statement.

Well, generally, Wisconsin as well as Minnesota from an economic view point have outperformed. And so -- we have a significant presence across Wisconsin. We can clearly do more in some of the bigger markets, particularly around Milwaukee, and we have got to focus on that. Looking to hire people. As well as Madison and up here in Green Bay and the Fox Valley. So we're making a concerted effort, frankly, across the footprint in the commercial banking space, to be a lot more active, and to go out and look for the very best people in the marketplace that we can hire. And we're getting some good results from that and hiring folks from places that we traditionally have not hired them from before. So that's -- we're very encouraged right now.

Thanks, Phil.

(Operator Instructions). Our next question is from Heather Wolf at UBS.

This is actually [Alina Kidd] stepping in for Heather Wolf. I think most of my questions have actually been answered. I have one remaining question, which is about your [term CRE] portfolio. I noticed that there was an increase in TDRs and 30 to 89 day delinquencies, and I was just wondering if you could provide some color in terms of what you're seeing?

Scott, could you answer that?

Excuse me. This is Scott, and I've got a horse throat. I'm sorry.

Your voice sounds worse than mine today.

We had a couple of large credits, two individual credits in the CRE book that went past due administratively over quarter end. Both of those have been subsequently renewed, so that was the 30 to 89 day bucket that went past due. I'm sorry, thesecond half of the question?

The run-up in TDRs.

Oh, run-up in TDRs. Yes. We have been a couple of A/B note restructures, whereby we'll charge-off the B note and take the A note and put that traditionally back on accrual. But it will remain as a TDR. So we've done a number of those in the stabilized income producing book, and that's what you are seeing.

Okay, great. Thank you.

Our next question comes from Peyton Green with Sterne, Agee.

Yes, good afternoon. A question in terms of the margin recovery that you had hoped to see. What kind of marginal investment rate are you getting on the securities that you're buying? And then also separately, what kind of roll-down do you expect over the next quarter and also the next 12 months because of the drop in yields that you referenced?

Peyton, this is Joe. We're expecting the fourth quarter cash flow from our investment portfolio to be close to $500 million, and we expect to reinvest that money at about 2.25%, because we're staying very short, and that's about 100 basis point decline from what the roll-off is. I don't have good numbers for going into 2011, but that is what is happening right now, so itis putting pressure on our margin.

Okay. And how much of the overnight money will you deploy?

Well, again, we don't think we need the$2-plus billion worth of overnight money. We are investing that in the short run as long as it stays in the treasury department. The best thing we could do is to deploy it into loans, and I think Phil alluded to, we're going to be putting some mortgages on our books that we've traditionally sold in the secondary market. We're going to hopefully get some commercial loan growth. So we'll be -- we try to deploy a fair amount of it. Clearly until we get upgraded to [B] investment grade, westill need to be very aware of our liquidity issue, and wehave tentatively thought that if we got that to half, that that would be an appropriate place to continue to run the bank that we were up upgraded. So somewhere in the neighborhood --

We would like to see it down around $1 billion toward the end of the year if we can get there.

Okay. And then just kind of generically, I mean what is the production capacity -- or was it in the third quarter on the 15-year mortgage paper in footprint?

We're hopeful of putting on probably several hundred million dollars during the fourth quarter.

Okay. All right, great. Thank you very much.

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

All right. Well, thank you very much, everyone. We're, as I said, quite pleased with the progress, and we're quite pleased with the positioning we have going forward. There's headwinds in the industry, of course, butI think that with the work we've done over this past nine, ten months we're really starting to see the results. So thanks for your interest in Associated and please give us a call if there's anything you want to follow up on.

Ladies and gentlemen, thank you for your participation in today's conference. Please remember there will be a replay running from 8 PM tonight until November 21. The replay numbers are 800-642-1687 and 706-645-9291. Once again, thank you for your participation in today 's conference. You may now disconnect.