Associated Banc-Corp (ASB) 2010 Q4 法說會逐字稿

Good afternoon, everyone, and welcome to Associated Banc-Corp's fourth-quarter 2010 earnings conference call. My name is Sayid and I will be your operator today.

At this time, all participants are in a listen-only mode. We will be conducting 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) As a reminder, this conference is being recorded.

Management will be referencing a slide presentation during their prepared remarks. A copy of the slide presentation, as well as the earnings release and financial tables, are available on 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 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 and the risk factors section of Associated's most recent Form 10-K and subsequent Form 10-Q.

Now, I would now like turn the call over to Philip Flynn, President and CEO of Associated Banc-Corp.

Thanks, and good afternoon, everyone. Thanks for joining us today. Joe Selner, our CFO, and Scott Hickey, our Chief Credit Officer, are with me today.

2010 was a year of significant accomplishment for the Company. We strengthened our balance sheet and we made progress in positioning the Company for future growth. Today I'll discuss our fourth-quarter results, followed by an update on our businesses and what we are doing to ensure profitable growth in the coming years.

Fourth-quarter highlights are outlined on slide three. We're pleased to report net income of $6.6 million, or $0.04 per share, which follows net income of $6.9 million, or $0.04 a share, last quarter. As you know, addressing our credit problems was the top priority in 2010. The results of the actions we've taken are evident in the significant year-over-year improvements in our credit metrics.

We continue to be encouraged by the decline in nonaccrual loans, down 21% from the third quarter and 47% from a year ago. This is the third consecutive quarter of declines in nonaccrual loans. Likewise, potential problem loans and past due loans were both down for the fourth consecutive quarter.

We sold and resolved nonaccrual loans with a total net book value of $163 million during the quarter, bringing the total of significant nonaccrual loans sold or resolved during the past year to $597 million. That compares to our stated goal of $500 million. While we may sell individual problem loans going forward, we expect that this is the last of our bulk loan sales.

As noted in the release, a fourth-quarter reduction in higher risk construction loans, which was primarily related to the loan sales, was offset by lower risk residential mortgage and home equity loans. Our net interest margin improved to 313 basis points for the quarter, up 5 basis points from the prior quarter, as we managed the cost of funding down. The Company's capital ratios remain very strong. Our Tier 1 common ratio was 12.26%.

Now, I'll get into more details about our fourth-quarter results, beginning with the loan sales. The charts on slides four and five provide additional details about the bulk and individual loans sold or resolved during the fourth quarter and the full year. We sold more than 50 notes during the fourth quarter, and on average we received about $0.80 against the net bank balance, the balance on our books minus the FAS 114 reserves we held against the specific loans sold.

Slide six shows the continued decline in nonaccrual loans. At $574 million, nonaccrual loans were down more than $600 million from the peak of $1.2 million only three quarters ago. Two loans accounted for the increase in new nonaccrual loans from the prior quarter. Given the low levels of new formation of nonaccrual loans we're now experiencing, you should expect some lumpiness in any given quarter going forward.

On slide seven, you can see the year-over-year improvements we've made in our credit metrics. The ratio of nonaccrual loans to total loans improved to 4.55%, down almost half from the peak of 8.87% at the end of the first quarter. Our overall level of reserves continues to be strong at 378 basis points of total loans at December 31, and the coverage of nonaccrual loans increased to 83%, up from 72% last quarter.

On slide eight, you'll see the potential problem loans dropped below $1 billion, to $964 million. That's a $632 million, or 40%, decline from a year ago.

Slide nine shows the downward trend in loans 30 to 89 days past due. At $120 million on December 31, loans past due were about half of what they were a year ago. We continue to be encouraged by the overall improvement in credit migration. The conservative recognition of our credit issues a year ago, and the aggressive efforts to work through those issues during the past four quarters, will contribute greatly to the Company's success going forward.

Slide ten outlines the key drivers of the provision for the quarter. Net charge-offs of $108 million included $42 million of charge-offs related to the loan sales and discounted resolutions. We released $27 million of FAS 114 reserves, specifically related to the loans sold and resolved during the fourth quarter, and released an additional $11 million in reserves for the remaining FAS 114 loans due to restructurings and pay-offs.

Slide 11 details the quarter's net charge-offs. In addition to the $42 million related to loan sales, there were two relatively large commercial charges totaling about $16 million, leaving about $50 million in more normalized charge-offs. We expect a significant decrease in provision and charge-offs in 2011, now that we have completed our bulk loan sales.

Turning to slide 12, our capital ratios remain very strong. As mentioned, the Tier 1 common ratio was 12.26% at the end of the year, compared to 7.85% a year ago, and our total capital ratio was 19.05% at the end of the quarter, compared to 14.24% a year ago.

Let me move on to some select balance sheet and income statement items. Slide 13 provides a snapshot of our loan portfolio, which totaled $12.6 billion at year-end. Total loans grew by $244 million, or 2%, from $12.4 billion at the end of the third quarter. As noted in the release, a 25% decline in the higher risk real estate construction portion of the portfolio was offset by increases in lower risk residential mortgage and home equity loans. We retained over $600 million of our in-footprint residential loans during the quarter, and we expect to hold a total of approximately $1 billion by the end of the second quarter.

On a year over-year-basis, the most significant decline was in the real estate construction segment of the portfolio. At $553 million, construction loans were down 60% from a year ago, and they now represent only 4% of the total loan portfolio. At $3.4 billion, the commercial real estate segment represents 27% of the portfolio at the end of the year, down 3% from the third quarter, and 11% from a year ago. We expect mid-single digit increases in average loans for 2011 and we expect commercial loan growth momentum will build as the year progresses.

Turning to slide 14, total deposits were $15.2 billion at year-end, down 9% from $16.8 billion at the end of the third quarter, and 9% from a year ago. You can see the year-over-year shift in our deposit mix. Lower cost demand deposits and savings balances were up 13% and 5%, respectively, while interest bearing deposits were down 40% and money market balances declined by 6% from the end of 2009.

On slide 15, you can see, as planned, we began to aggressively manage down some of our higher cost deposits, including our network deposits and CDs, during the fourth quarter. As a result, nearly $1.1 billion of higher cost liabilities were managed out. We also, in general, reduced the rates paid on our core customer transaction accounts. However, the net transaction account impact was modest, as these balances declined by $133 million during the quarter. Year-end seasonal effects, lower earnings credit rates on corporate balances, and the influx in year-end DDA balances related to the phase out of the FDIC's TAG program influenced these balances.

Looking forward, we expect modest growth in customer deposit and sweep balances, and continued runoff in the network and brokered funds. As you'll recall, throughout the year we've been maintaining a sizable liquidity position. As our ratings improved, and our access to alternate lower cost funding improved during the fourth quarter, we began to manage that position down.

By the end of the quarter, we had redeployed approximately $1.7 billion in cash by investing $810 million in securities, funding net growth in loans of $160 million, and reducing our net funding by about $670 million. As a result of these actions, the Company's -- and the Company's continued efforts to manage down its rates paid on deposits, the Company's net interest margin grew to 313 basis points for the fourth quarter, up 5 basis points. The securities purchases were predominantly agency-backed CMOs and the investments were weighted toward the end of the quarter.

As such, much of the investment benefit during the fourth quarter was offset by the impact of continued runoff in our CRE loan book and lower yields on our residential loan portfolios during the quarter. Given a stable rate environment, we expect our net interest margin to expand modestly as we move further into 2011.

On the liability side, we believe that the rebalancing and deposit pricing actions we took during the fourth quarter will continue to have a positive impact on the Company's net interest margin in the first quarter. We expect the net interest margin in 2011 will expand by 10 to 20 basis points over the course of the year. We expect the margin in the second half of the year to be stronger than in the first half, as projected loan growth later in 2011 begins to contribute more strongly to our expected margins.

Non-interest income of $85 million was up 3% from the prior quarter and flat when compared to the same quarter a year ago. A $4 million increase in net mortgage banking income and a $4 million increase in capital markets income was partially offset by a $3 million decline in service charges on deposit accounts. Net mortgage banking income was up 47% from the prior quarter as loan volume exceeded our expectations.

In regards to consumer fee income, like the rest of the industry, Associated faces significant headwinds due to changes in consumer behavior and the impact of Reg E and the proposed Durbin amendment. Service charges on deposit accounts of $20 million were down 15%, from $24 million in the prior quarter, and down 30% from $29 million last year. The reduction is primarily due to a reduction in NSF OD fees as a result of changes in customer behavior, our compliance with Reg E and proactive steps the Company has taken to manage customer experience. We're projecting NSF OD fees of $40 million to $45 million in 2011, which is down about $10 million from this year.

As you know, the Federal Reserve Board's proposal to restrict interchange fees on debit cards was much tougher than generally expected. We estimate the impact of the proposed new rules, as they now stand, will be about $12 million to $13 million for the second half of 2011 and slightly more than twice that amount in 2012.

Last summer, we revamped our checking suite of products for consumers and small businesses, most notably with the elimination of free checking as an offering for new customers. Throughout the fourth quarter, we contacted our existing free checking customers in a successful effort to convert those who qualify, based on minimum balances or activity levels, into no-fee checking products. We'll begin charging customers that remain in the former free checking category during the first quarter of this year.

We've seen some attrition of low balance accounts, approximately 3% of our total consumer checking portfolio, as a result of these and other changes. While the total number of consumer DDA accounts is lower than a year ago, the consumer household base is stronger in terms of average balances. Balances on new accounts were up more than 60% from a year ago, and we also saw increases in account utilization and cross-sold products.

It's not our intention to replace fee income losses by charging other fees to the same customer base. Our emphasis will be on accelerating our efforts to attract and retain true core households and capturing the organic fee income that comes through deeper relationships with those customers.

We expect non-interest income will be down close to 10% in 2011 due to mortgage banking and service charge headwinds.

Non-interest expense was up 7% from the prior quarter and up 5% from the same quarter last year. Expenses were up on a linked-quarter basis primarily due to higher performance based compensation, most notably in residential lending, and other ongoing investments that are tied to our strategic initiatives. While our head count remains relatively flat, we made a significant number of upgrades in talent during the past quarter.

Foreclosure and OREO expense was up $2.5 million, or 34%, from the prior quarter, primarily due to write-downs of several properties. And in addition, other non-interest expense for the quarter included a one-time $5 million pre-tax increase in litigation reserves related to a specific legal matter. We expect mid-single digit increases in non-interest expenses in 2011, driven by the strategic investments we're making in our systems and infrastructure, and in additional talent.

Slide 16 represents the Company's business portfolio and outlines how it's organized today. In the past, there was a heavy reliance on our retail banking business to grow deposits and a similar reliance on commercial banking to grow loans. With the recalibration of our business portfolio, we've created a more balanced approach to growing the business and realign some of the business units to maximize sales opportunities and optimize customer fit.

The mortgage and consumer home equity loan segments of our retail banking business have been combined to create a new residential lending business unit. This unit performed well during the fourth quarter, with loan volume exceeding our expectations. We began the rebalancing of our originate to sell and portfolio strategies this quarter, with the previously mentioned retention of more than $600 million of in-footprint residential loans. We're also broadening our approach to residential lending through the development of a multi-channel approach to loan origination, which will help us achieve growth through all the right cycles.

Business banking to smaller companies now resides in our retail banking business. We again saw an increase in loan applications in business banking during the quarter. In fact, December was our second highest month of the year in terms of loan apps. We remain focused on better leveraging our branch distribution system to grow this segment of our retail business.

We've also created a separate retail payment business under retail banking, to increase our organizational focus on the rapidly evolving and changing payment transaction market. Our first objective here is to ensure that the Company's competitive in terms of new technology, products and services. We've talked in the past about our need to make some investments in our branches. This year, we'll begin executing on a five-year plan for branch and signage upgrades throughout our footprint.

Turning to commercial banking, we believe the economy is modestly improving in our markets. While loan demand industry-wide remains relatively weak, we continue to see some positive signs with another quarter of modest core C&I growth. Utilization rates remained relatively flat during the quarter at about 42%. Based on what we're hearing from our customers about inventory levels and customer demand, we believe that those rates may move up during 2011.

Our total pipeline for commercial loans remains strong, with growth of more than 20% since the middle of last year. While there continues to be a lot of competition for new business, loan pricing remained relatively stable during the quarter. We continue to invest in new talent across our footprint with the addition of a dozen or more seasoned, experienced bankers in both our commercial banking and client solution groups during the quarter.

In June, we announced the creation of a national specialized financial services group within our commercial banking business to capitalize on opportunities in targeted industry segments. With that, we hired a number of specialized industry experts who are leading this effort. We saw good loan growth in this group during the past quarter, with insurance and mortgage warehouse lending driving the growth. So in addition to existing units, including mortgage warehousing, public funds and financial institutions, we're expanding into other market niches, including health care, insurance, oil and gas, and power generation.

While it will take some time to build this group's business, we believe the specialized financial services group provides our Company with an opportunity for significant C&I and non-interest income growth, both within the footprint and nationally.

We clarified the organizational responsibility for the commercial real estate segment during 2010. As previously announced, we hired a new leader to head up our commercial real estate efforts. We continue to bring in additional talent as we gear up for increased activity in this area. We believe this is a good time to be active in commercial real estate, with lower valuations and conservative loan structures. In addition, there's been a weeding out, if you will, of players on both the commercial bank side and the real estate development side, which will lead to great opportunities for us going forward.

The treasury management business is a critical pillar of our commercial banking relationship strategy and we believe it will be a strong driver of core deposit growth for the bank going forward. We're making product and process enhancements that will allow our bankers to effectively bring all of our products and services to this range of existing and potential clients.

Trust assets under management and our wealth management business were $5.7 billion at the end of the fourth quarter. Trust service fees of $9.5 million were up 1% from the prior quarter, and year-over-year grew 5%. Our wealth management business has been a steady earnings contributor over the years. However, we believe there are substantial growth opportunities to be captured by more closely aligning this business with our other core businesses.

Moving our insurance brokerage to the commercial bank and the investment brokerage to our retail bank will allow us to optimize customer relationships and segment fit. Wealth management's core business, private banking, trust and asset management, is showing good growth, as we continue to make investments in additional talent and implement cross-selling strategies to capture internal opportunities to grow.

In summary, we made a lot of progress in 2010. We strengthened our capital position, we improved our credit metrics, and we returned the Company to profitability. We also spent a good deal of time during the past year looking at our core businesses, and developing plans to ensure the profitable growth of the Company.

2011 will be a year of transition as we execute our strategic initiatives. We will bring in additional talent, enhance our management reporting systems, and begin to invest in branch upgrades throughout this three state footprint. These ongoing investments will strengthen our core businesses and position the Company well for more rapid growth in 2012 and beyond.

So that concludes my prepared remarks, and now we'll open it up to your questions.

Thank you. (Operator Instructions)

First question comes from Scott Siefers from Sandler O'Neill.

Good afternoon, everybody. Just a couple of quick questions.

First, was hoping for any additional color you can shed on the potential for TARP repayment. You've said, and then reiterated in the release, that it would be hopefully this year. I guess, from the way you're thinking about it, is that something you'd like to do sooner or later, or are there any other things you want to accomplish internally before you begin those discussions with the regulators? And I guess, does the regulatory agreement enter into the equation at all?

Our desire is to repay TARP sooner than later, but we also desire to be sure that we pay it back in as shareholder friendly as -- friendly manner as possible. So we have been entering discussions. We're very confident we will get this paid off this year. But as I've said, we're going to be very deliberate about how we do this so that we can minimize any potential dilution. The MOUs with the Fed and with the OCC really don't enter into that equation.

Okay. Good.

And then just sort of a tick-tock question. I think you had mentioned a one-time expense item, I think it was litigation related. Would you mind going over that quickly one more time and just any additional color you can provide on it?

Yes. I don't want to give a lot of detail about litigation matters, but there is a one-time $5 million non-interest expense item regarding a specific piece of litigation.

Okay. Perfect. That's what I needed. Thank you.

Thanks.

Thank you.

Our next question comes from Ken Zerbe from Morgan Stanley.

Thanks.

Two questions. First, maybe you can go over in a little more detail sort of the, I'll say the rationale or just help us understand the reduction in, you basically reduced core deposits and you replaced it with short-term borrowings, in the tune of $1.5 billion down and then $1.2 billion up. I understand that that did have a benefit to the NIM, but from sort of a structural perspective why try to manage out sort of other low cost deposits?

Yes. The deposits that we managed out are arguably really not core deposits. These were relatively large, in this environment, cheap, but not as cheap deposits as we can fund ourselves with. So these were not core customer balances. And what we've basically done is created some new repo sweep product where we've swept those deposits into repos.

Okay. And the benefit, and the benefit you got from doing that?

Is reduced costs for --

No, I mean, do you have, are you able to quantify the benefit?

Well, for the quarter so far we picked up about 5 basis point of NIM, but we expect that all the things we did in redeploying that liquidity position, including reinvesting short-term cash into CMOs and other shorter investments, is going to help that NIM grow as we get into this quarter and beyond. Most of the investment activity occurred in the latter part of the quarter, so we haven't seen the full benefit of that yet. So we did a number of things but it was all, Ken, based around redeploying that liquidity position that we had built up early in 2010, which we just don't need to carry around anymore.

All right. Understood.

Then the other thing I wanted to ask about was the sale of non-performers. If I've got my numbers right, it was $42 million of charge-offs on $163 million of, I guess, resolution/sales.

Right.

You guys have done a great job of reducing the NPA balances over time, but I guess my question is, why shouldn't we just extrapolate out the 26% additional severity on your non-performing balance of over $500 million and say that as you resolve those, we're going to see another $100 plus million of losses?

If I could wipe out all of my NPAs for another 100 million bucks, I think you'd probably applaud, to tell you the truth.

But I guess it sort of also implies that your NPAs are not written down to realizable value, and I guess that was more the concern.

We've had that discussion with other folks all year long. When you sell a non-performing loan, the buyer is going to expect some return beyond whatever the market value for example or the appraised value of a piece of real estate is.

Yes.

I've been very pleased with the resolution of our NPAs all year long. And you also have to remember, you should net back the FAS 114 specific reserves that we carry against those. So in addition to the -- if you take the 43 of charges we released, what was it Scott, $26 million of FAS 114, tied to those loans. So we think about those two numbers together as the cost of resolution.

Okay. Thank you.

Thank you.

Our next question comes from Emlen Harmon from Jefferies.

Good evening. Can you hear me okay?

Oh, no problem.

Oh, great.

How are you?

Good, thanks.

You know, with you guys kind of approaching the end of the bulk sales here, could you talk a little bit about where the reserve resided longer term and just your outlook for reserve release going forward?

Yes. I mean, as you've seen over the last two quarters, we've released roughly $100 million of reserves, as we've moved down the NPAs. I mean, just for a little perspective, the loan loss reserve over the course of the end of 2009 to the end of 2010 has been reduced by about 17%. We've reduced our non-performing loans by 48% during that period of time. So yes, it is -- we project that we will continue to release reserves as we go through 2011. We're still carrying a very high level of loan loss reserves, so you should expect releases going forward. But overall what you're going to see with us not doing bulk loan sales is much lower levels of charge-offs and much lower levels of reserves as we move into this year.

Got you. Thanks.

I guess just one other question. During the mortgage growth, you gave us some pretty good color in terms of what to expect in the first half of next year. Could you tell us a little bit more about maybe where you're comfortable growing that portfolio to, longer term? And just kind of how you think about the profitability of that business compared to other business lines?

Yes, you know, we think we can build a very profitable and successful mortgage business here. We already have one. We're the largest mortgage originator in Wisconsin. We are not going to put on too much long-term fixed rate loans onto the balance sheet. There's a lot of interest rate risk, if you get this too large. So right now our plan is to build up the 15-year and under mortgages to roughly $1 billion in the second quarter, pause and see where things are.

Okay. Thanks a lot.

Thank you.

Our next question comes from Jon Arfstrom from RBC Capital.

Good afternoon.

Hi, Jon.

Just a follow-up on the charge off question. Anything -- is that large charge off something you consider an aberration? Is there any story behind that?

There were just -- you're looking on slide, what was it? 12, 11.

Yes, 11.

Yes. We just called that out because these were a couple of unusual charges on stuff that we're still holding on our books. And the point of that was to give folks a sense for absent loan sales, bulk loan sales, kind of what we think a reasonable core organic charge-off rate was for the quarter, and that was about $50 million.

Okay. I may be misreading this, but you're talking about a significant decline in provisions and charge-offs, and also some reserve releases in that core $50 million charge-off number. Is that the kind of level that you think we can expect early in 2011 or is it too difficult to draw that conclusion?

It's hard because, you know, any particular quarter is going to bounce around. But we believe that throughout 2011, this probably represents a reasonable run rate, could be a little better. Could be a little bit lumpy. But, you know, this year we charged off about $490 million, a lot of that being driven by bulk loan sales. So with that over, you know, you can subtract all that bulk loan sale charge off and get to a more normalized rate. As we go through the economic cycle and things continue to improve, of course, these charge-offs will abate from there, as we go through 2011 and into 2012.

Okay.

Couple more things. How much contribution is the specialized lending business giving you, in terms of some of your growth?

We got some nice growth from mortgage warehouse lending this past quarter. It was a decent chunk of the commercial growth, but we experienced growth in the normal middle market and corporate areas as well, in the various regions. We have three regions that we operate in, organizationally, in commercial banking. So as time goes on, specialized lending, I think, will contribute nicely, but, you know, it's an add-on to the core commercial banking business. Certainly won't dominate it. I think, as you know, I have quite a bit of background in specialized lending as do some folks that have joined us recently. I think it's a good business to get associated into and it provides us a lot of geographic and product diversification.

Okay.

Just two other questions if I can. Assuming you do get out of TARP at sometime in 2011, you know, I look at your capital situation and it looks very strong relative to a lot of the other peers.

Right.

Are you open to using some of the excess capital that you have to reduce the share count?

Well, you know, that's all into the future, obviously. We've got -- we can't really do anything on dividends or share buy backs until we repay TARP, improve our core profitability, and all that I think is going to happen this year. I'm highly certain we'll pay back TARP in 2011. Hopefully sooner than later, and then when that's done and we see continued growth in core earnings, we can start to revisit those kinds of questions. But we're a ways away from that, in all honesty.

Okay.

Just, last question. I'm assuming the three regions are Illinois, twin cities and Wisconsin --

Roughly, yes.

Yes. Just curious if you have any change in your plans, given the consolidation that's happened in the Wisconsin market?

Well, we, we think there's a big benefit to Associated Banc there, obviously. We will become the largest bank headquartered in Wisconsin, once that transaction closes later this year.

Okay.

We are, frankly, advertising that fact. And we're getting a significant amount of interest from companies that weren't necessarily interested before. And we're also getting significant interest from very high quality bankers. So I think this is a real potential benefit for us. I mean, just honestly.

Yes. Okay. Seems that way to me. Thank you.

Yes.

Thank you.

Our next question comes from Tony Davis from Stifel Nicolaus.

Phil, in that regard, I wanted to congratulate you. Thanks to Bank of Montreal, it looks like you'll achieve your plan or your goal of becoming the largest bank in Wisconsin. When you look at where you've been expanding, I wonder where you stand in terms of building out the Chicago relationship manager and overall private banking staff? I guess what I'm asking here is, sort of, have you caught up with the staffing that you need there and you can begin to add people, I guess, maybe at a more deliberate pace?

I think that's fair. We've hired, during the course of 2010, a lot of really great people in Chicago in commercial banking. We'd still like to, across the footprint, add some more people in private banking and we've been doing that. But I should tell you that particularly with the change here in Wisconsin, we're always on the lookout for high quality bankers, and so yes, we'll be -- we've been deliberate all along. We haven't just thrown bodies in Chicago.

Right.

But we'll have some opportunities probably to add some folks here at Associated Banc-Corp who are very well established in, in places like Milwaukee and others.

You talked about the specialized financial services group. Two questions there. I guess have you hired or transferred any loan officers into that unit at this point and, and I guess, too, this is designed to be a national business. Any thoughts you may have about how much of the loan portfolio you want to have residing outside of the core footprint, long term?

Yes. We've already hired folks for these businesses. We've hired someone to focus on oil and gas, someone to focus on power. Some of these other businesses we've had and we've added additional staff to. We still have some staffing to do in specialized lending, but we've made great strides there.

This is a business, you know, that I grew up in banking in, and I can assure you that although we expect great things from it, we will be growing it at a moderate and measured pace. Where we finally end up as far as what's in the three state footprint, as far as assets go and what's outside, it will take quite a bit of time until you see any meaningful amount of growth outside the three state footprint, anything that really is going to make a difference here.

Okay.

The secret to building up any loan business is to be deliberate about it.

Absolutely. Thank you much.

Thank you.

Our next question comes from Erica Panella from Bank of America.

Good evening.

My first question is a follow-up to Ken Zerbe's. I guess I was wondering if you could tell us what the cost of the deposits that you manage out versus the borrowings that you put on to replace them?

Erica, I don't have that level of detail in front of me. We could follow-up with you on that. I mean, we're probably picking up 5, 10 basis points, and at the moment there's also a benefit on FDIC insurance. That will change as we get later into the year, but there's a benefit in not bearing that cost.

Got it.

And within your 10 to 20 basis points guidance as expansion for 2011, could you give us a sense of how much more you would dial down your liquidity in that scenario and the size of your bond portfolio?

Well we're not going to dial down the bond portfolio. I mean, we have just invested into it, so that will probably run at about the level that it is today. If we get the type of loan growth we expect as, as cash flows come off of that, we'll use that to fund loan growth. So ultimately, you know, we have too big of an investment portfolio today just because of the lack of lending activity over these last few years. I'm sorry. What was the first part?

The first part of the question was the cash balances.

Yes. We have re-balanced that liquidity position to where it needs to stick. We're roughly at around $500 million, give or take, of short overnight type of investments and that's where we'll be. So we've run it down a lot this quarter from over $2 billion to about $0.5 billion, but that's an appropriate level for us to stay liquid at.

Is there a securities to earning asset target that we should be looking at when we're thinking about it in conjunction to that type of margin expansion? Does your model say, for example, if you can get down to 35% that's enough of a lift?

You know, the more important feature is we, you know, we want to remix this portfolio back toward much heavier in loans and much less in securities. I don't have in front of me a target, particularly. You know, we think we're going to grow the loan book about 5%, year-over-year, and a lot of that as we get later into the year will come -- will be funded by a run-down in the securities book. But it's not going to move real dramatically during 2011.

As we get further into 2012 and 2013, we expect the investment portfolio to shrink a lot more. But it will be shrinking because it's funding higher margin relationship loans where we're also cross-selling other products.

Got it.

And on the -- is it too early to give us a sense of what kind of revenue lift you would expect to garner from your, the wholesale changes that you made on deposit fee pricing?

It's too early. You know 2011 is -- we're going to face real headwinds because of Durbin and the full-year effect of Reg E. And, in fact, I do believe our non-interest income is going to be down probably close to 10%. It will be down even more than that, other than all the other initiatives we're taking to try to build up. But as time goes on, and we build a higher quality relationship-driven business, particularly in the consumer side, as well as build out our penetration on commercial deposits, we will start to make up for that and more.

Got it.

And my final question is, on the expense guidance, the mid-single digit growth is off of a base that excludes that $5 million litigation expense?

Yes, that's a one time deal.

Okay. Thank you.

Thanks.

Thank you. Our next question comes from David Conrad. Our next question comes from Dave Rochester from Credit Suisse.

Hello, guys. Thanks for taking my questions.

Hello, Dave.

I know you've talked about increased competition on the C&I side but that it didn't impact pricing. It looks like the yield on C&I portfolio was actually up 13% basis points for the quarter sequentially. Can you talk about what drove that increase and was that growth in that mortgage warehouse portfolio you talked about?

I'm sorry. Go ahead, Joe.

The quarter is affected by lower non-accruals. At the end of last quarter, right at the end of the quarter we sold a couple hundred million dollars of loans and they weren't there, so that helps it, plus obviously maintaining, you know, discipline on pricing. So it's a combination of both of those.

Okay.

And can you provide maybe a little bit more color on where you're seeing the increase in competition? Is that across the board in loan size, and are you seeing it from larger banks and smaller banks?

Yes. I mean, I think it's an industry-wide fact that the banking business is chasing commercial borrowers like crazy. We're getting -- we've now had two consecutive quarters of growth in commercial loans, which is somewhat better than I've heard other banks talking about. The reason for that is that we've significantly revamped our commercial banking teams. We've hired some really good people who have a lot of tenure and a lot of knowledge about the markets they're in, and so we're picking up our share because of the quality of people we have out on the street. It's not because, you know, other banks don't want the business. We're winning the business, based upon our relationships.

Sounds good.

And one last one. Back on TARP repayment. Would you happen to have the cash level at the holding company, is that still at a $300 million level, at this point?

It's almost $400 million today.

And then the cash usage per quarter, roughly?

It's pretty low. What, do we use in the quarter in the holding company, roughly?

Dividends. Interest expense. It's $4 million, $5 million, probably, a quarter.

Yes.

So you know.

It's really --

Call it $20 million or $30 million a year. Yes, so we don't use much cash up there.

So you've got a ton of cash. I mean, it seems like it would be fairly easy for you guys to do a partial repayment nearer term. Is that something that we should expect, and then maybe, given you're stronger capital ratios, you could potentially pull off funding the rest of the TARP repayment with debt?

I'm going to send you down to the Fed to negotiate for me.

[Laughter]

Yes. We believe that, given our cash position, and given our extraordinary high capital levels, that we should be able to repay TARP without significantly diluting our shareholders. But we don't control that. We are going to be very deliberate in the way we go about this and very deliberate, as we talk to our regulators and the Treasury, to do the very best we can.

Great. All right. Thanks, guys, appreciate it

Thank you. Our next question comes from Steve (inaudible) from Macquarie Holdings.

Hello, guys.

Hello.

Just a quick question for you. I know, you've mentioned earlier that you are kind of coming to the end of the bulk loan sales and I was just curious, you know, given the increase in the pricing there, it's you know about $0.80 on the $1 that you guys have been able to realize and you still have more things to resolve. I'm wondering, you know, why turn off the spigots now? And maybe we'll start there.

Sure. At the very beginning of last year, we, we told the world that we intended on doing bulk sales to get our non-performing loans down as quickly as we could, and that we would sell the worst stuff first and we'd sell the better stuff later. And that's what happened, and that's why you saw reasonably good pricing. We have sold a lot of our bigger non-performing loans. A lot of what we have left are smaller, and a lot of what we have left now, we believe that ultimately we will do better by going through a traditional work-out process. And so from this point forward, that overwhelming need to get the non-performing levels down to a reasonable amount has been accomplished. Going forward now, we can do best for our shareholders by not selling them in bulk, and collecting more than we otherwise would by selling them.

Got it. So even if it takes a little bit longer, you still feel the ultimate resolution will be much more favorable kind of working them out the traditional process.

Right. We're still sitting at 455 basis points, which is still higher than peers, but it's not the frightening 9% that we were looking at not too long ago.

Right.

I mean, we now have the luxury of taking our time and resolving these at the highest price possible, you know, recovering as much as we possibly can.

Got it. Makes sense.

Just real quick, back on kind of the liquidity deployment. I know you put about $1 billion to work there. I'm just curious, is there, you know, any other kind of strategies or any other, you know, material moves that you can make or plan to make during the year to kind of continue to, you know, drive up that margin or achieve, you know that 10 to 20 basis points of expansion that you targeted? For example, is there more room for repricing on the deposit side, or more mix shift? What are going to be the key drivers of that 10 to 20 basis point increase?

Yes, you know, the fourth quarter from a restructuring perspective, we did an awful lot. There isn't much more to do there. We need to maintain about $500 million of liquidity, and that's where we're at. The growth in margin is going to be continued discipline on deposit pricing. We'll continue to be disciplined there, but there's only so much you can do in such a low interest rate environment, and we've been very deliberate about managing that, for a long time.

What we really have to have now is loan growth which will drive that margin expansion. We believe we're going to get that. We also will get, for example this quarter, a full quarter's effect of the moves we made in the fourth quarter because all of that was going on throughout the quarter, and particularly the reinvestment occurred in the latter part of the quarter. We'll get a little pick up still from all the moves we made in the fourth quarter. But after that, we believe given, you know, a relatively flat rate environment, which is what we expect now, loan growth is going to help with NIM expansion.

Right. Makes sense. Thanks so much.

Sure.

Thank you.

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

Good afternoon.

Phil, I was wondering if you could talk a little bit about the loan portfolio. I guess over the past two years it's dropped maybe 20% to 25%, peak to trough. I was wondering if you can maybe characterize the potential move up and the utilization rate. I think you mentioned it was around 42% at the end of the year.

And then secondly, what's the longer-term opportunity of the specialized lending business? I think you characterized the mortgage business as being $1 billion kind of addition over about a period of a year. Even if it's longer term, how much of your liquidity do you think the specialized lending business can absorb? And then offsetting that, do you think, is there anymore real intentional runoff in order to prune elements of the portfolio back?

Sure. So from peak to trough, the overall loan portfolio dropped about 25%, give or take about $4 billion. We've seen a little bit of growth now in the fourth quarter, and we expect continued growth as we go through 2011, and, we think that we'll have about a 5%, give or take, growth in the portfolio average to average. Since the portfolio was declining throughout 2010 to get 5% average to average, the point to point is going to be significantly more than that,. So we're planning on, and we expect to get, pretty significant loan growth.

Specialized lending will help quite a bit, but it's not going to drive all of that by any means or even a real meaningful part of that, as we go through this year. It will grow much more slowly, so it's the basic core businesses, commercial banking, our residential lending area, that are going to drive most of our growth.

The $1 billion you were referring to isn't the mortgage warehousing business. That's the $1 billion which we plan to hold on our balance sheet of 15-year and under residential mortgages. We've put about $600 million on over the past two quarters. We'll put on some more, up to about $1 billion.

Yes. No, that's what I was mentioning. I'm sorry I wasn't clear about it.

That's fine.

Longer term, how much of the loan portfolio, maybe on a relative basis, do you think the specialized lending business could be? I mean, just conceptually to have a framework.

Maybe 10% of the loan book, ultimately.

Okay.

Yes.

All right.

And then, are there, is there any more kind of intentional runoff due to burning that you expect going forward, or has that been pretty much done?

Nothing meaningful now.

Okay. Great.

And then, Joe, a couple questions for you. The yield on the CMOs that you all bought in the quarter? And then how much cash flow from the portfolio do you expect to leaven, and what's the roll off yield?

Should have asked Chris all these questions. The yield in the portfolio acquisitions were in the 2's.

Okay.

Because again we were really short. The cash flow that's coming off is $150 million to $200 million a month, $200 million a month. So we have really robust cash flow. And we can reinvest it, we can use it to fund loan growth, whatever we need to do. And the portfolio yields have been coming down, so I would suggest that the yield give up, the stuff that's coming in, the mortgage stuff, isn't significantly higher than what we've been putting on. It's probably in the 3% range.

Okay. Great.

And then the mortgages that you're putting on balance sheet, the 15-year and under stuff, what kind of yields are those coming on?

4's.

Okay. All right, great. Thank you very much

Thank you.

Our next question comes from Heather Wolf from UBS.

I think my questions have been answered.

Thank you.

Our next question comes from Terry McEvoy from Oppenheimer.

Thanks. Just one quick question.

Joe, as pre-tax income continues to grow, can you just help us out with the tax rate?

Yes. Terry, that's always a challenge, because obviously when you get down near 0 and you've got permanent items, the rate bounces around quite a bit, but at the margin as we grow revenue, and it's going to be taxable, you're putting it on at the margin at 39%. So it, the rate will continue to go back up to something approaching 30%. Now whether that will actually happen in 2011, but it's going to continue to go up because that's what's happening as you grow earnings.

(inaudible).

Okay. Thanks.

I'm showing no further questions at this time.

Okay.

Well, I want to thank everybody for your attention and great questions. As always, if you have any additional questions, give us a call. Thanks again for your interest in Associated, and with apologies to my associates and friends in Chicago, Go Packers.

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program for today. You may all disconnect, and have a wonderful day.