Associated Banc-Corp (ASB) 2011 Q2 法說會逐字稿

Good afternoon everyone, and welcome to the Associated Banc-Corp 2011 second quarter earnings conference call. My name is Tyrone, 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. As a reminder this conference is being recorded.

Management will be referring a slide presentation during the prepared remarks. A copy of this 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, beliefs, expectations, or similar forward-looking statements. Associated's actual results could differ materially from the results anticipated or projected in such forward-looking statements. Additional detailed information concerning the important factors that could cause Associated's actual results to differ from the information discussed today is readily available on the SEC website and the Risk Factor 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 Philip Flynn, President and CEO of Associated Banc-Corp.

Thanks 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 will provide you with our results for the quarter, along with an update on our strategic priorities and steps we are taking to grow our core businesses. I will begin by pointing out a few highlights from our second quarter results on slides three and four.

As we reported, net income to common shareholders was $26 million, or $0.15 per share. This compares to net income of $15 million, or $0.09 per share for the first quarter. Pre-tax income was up $13 million, and net income to common shareholders grew by $10 million over the prior quarter.

Our loan portfolio grew 3% to $13.1 billion during the quarter with the most significant growth in the C&I segment. The commercial real estate loans and residential mortgages also grew, as we began to see the benefits of the investments we are making in these areas.

As a result of our strategies to grow loans and improve credit quality, interest-earning loans, that is total loans net of non-accrual loans, grew by nearly $1 billion on a year-over-year basis to $12.6 billion, from $11.6 billion a year ago. Total deposits and customer funding of $16.1 billion was up $184 million. We continued to optimize our funding costs by driving non-customers network transactions deposit and brokered CDs down another 10% this quarter, while growing savings and interest-bearing demand deposits.

As you know, we completed a $300 million debt offering in late March and used a portion of the net proceeds to repay half of our TARP. Despite the added interest expense, our net interest margin was 3.29%, down only three basis points from last quarter. We expect to repay the remaining TARP during the third or fourth quarter, and will do so in as shareholder-friendly manner as possible.

We continue to be pleased with the ongoing improvement in our credit quality indicators, including a 4% decline in non-accrual loans this quarter. Non-accruals of $468 million are at the lowest level in six quarters, and represent 3.6% of total loans, down from 3.9% last quarter, and a high of almost 9% during the first quarter of 2010. Importantly potential problem loans declined $213 million, or 23% from the first quarter.

We recorded a provision for loan losses of $16 million, less the net charge-offs of $45 million. The lower provision and reserve release were driven by the ongoing improvement in the credit quality of our loan portfolio.

Our capital ratios remain very strong with Tier 1 common ratio of 12.61%, and a total capital ratio of 17.5% at June 30th.

If you go to slide five, you will find some information about our regional economy. The upper Midwest continues to be a positive place for business and banking. Jobs, output, and the outlook for growth are all moving in the right direction. The unemployment rate in each of our Midwestern states remains below the national average. In fact, most major metro areas in our footprint posted significant job gains year-over-year and year-to-date. What we are seeing in terms of loan growth is consistent with recent news about improvements in unemployment and a pick-up in manufacturing in the Midwest.

If you move to slide six, I can talk about our loan portfolio which grew to $13.1 billion at June 30th. This was up $434 million from March 31st. Our goal is for the portfolio to be roughly balanced in thirds. Today it is somewhat overweighted on consumer assets and somewhat underweighted on the commercial side, with 30% in commercial real estate and construction loans, and 25% in C&I loans. For the quarter we had new C&I production and line draws of more than $500 million. This growth was partially offset by about $300 million of run-off and paydowns, resulting in $230 million of net C&I portfolio growth.

From a line of business perspective, our specialized financial services initiatives contributed more than $120 million of this net portfolio growth, or about 50% of the net increase.

From a geographic perspective, Chicago was our largest metro area contributor, accounting for a little less of $50 million of the net growth. Wisconsin continued to be our largest state market, with over $80 million of net portfolio growth. Overall utilization rates remain low, but they were up slightly at 45% compared to 43% in the first quarter.

In commercial real estate we are starting to see a return on our investments for growth. We opened two new loan offices, one in Indianapolis and the other in Cincinnati during the first quarter. We closed our first deals in Indiana and Ohio this quarter.

In total, the CRE and construction portfolio grew by $50 million to $3.9 billion. Based on market feedback and what we are seeing today the quality of our commercial real estate book appears to have stabilized. As I mentioned in the past, we believe C&I and commercial real estate will be key drivers of our loan growth in 2012, while the markets become more competitive we continue to see good opportunities.

Ongoing improvements to our sales process and better sales management tools are aimed at helping our commercial and business banking teams. Our bankers follow a disciplined calling effort, with support from marketing to capitalize on what we believe will be continued disruption as a result of the acquisition of M&I. We expect these efforts along with the new talent we've hired will serve us well in the long term as we continue to actively pursue market share.

We hired 80 M&I employees during the past two quarters, more than half of them are in customer-facing and sales-oriented roles.

Competitive pressures increased throughout the footprint, contributing to the decline in our average yield for commercial loans, which was down 13 basis loans from the prior quarter. We continue to be price competitive where we see an opportunity to expand the client relationship through the offering of other products and services.

The consumer loan portfolio grew $157 million, or nearly 3% to $5.9 billion at the end of the quarter. In spite of the soft mortgage market, we saw a slight increase in mortgage banking volume, due to the lower than anticipated rate environment, and steps we are taking to position our residential lending business for greater growth. We anticipate a similar pace of growth for the second half of the year, based in part on the rate environment, but also fueled by several mortgage origination initiatives.

While we are pleased with our lending activity this quarter, we expect a slightly slower pace of growth somewhere in the range of 2% to 3% for each of the next two quarters.

If you move to the deposit slide on slide seven, our funding strategy continues to emphasize retaining core customers while deemphasizing broker and network funding. We have purposely increased our use of low-cost customer repo funding, as we continue to have excess securities collateral. None of our repo balances at June 30th were with banks or brokers.

We will continue to evaluate our funding strategy in light of the repeal of Reg Q, the new FDIC assessment rules, and the continued low interest rate environment. However we do not expect to see significant further expansion of either repo or FHLB balances. Total customer deposits and funding levels grew by over $300 million during the quarter, pretty much evenly split between transaction balances and term balances. During the period, we also further reduced our network and broker funding by 10%, or $120 million.

Net interest income is detailed on slide eight. We had net interest income of $154 million, which was up modestly compared to the first quarter. Overall deposit interest expense declined during the quarter, as we continued to aggressively manage our funding costs. Excluding brokered CDs the cost of interest bearing deposits fell by 5 basis points.

Our net interest margin was 329 basis points, down three from 332 for the previous quarter. As we pointed out in the release our net interest margin was impacted by higher interest expense related to the March debt offering, which resulted in a nearly eight basis point reduction this quarter. This reduction along with the impact of lower loan yields was partially offset by the previously mentioned lower rates on interest bearing deposits, and a higher than expected return on our investment portfolio. For the balance of the year we believe the margin will be impacted by the current rate environment, loan growth, and the net effect of funding for the expected TARP repayment. We believe this will result in modest pressure on the net interest margin over the balance of the year.

On a linked quarter basis core fee-based revenue of $61 million was relatively flat. Service charges on deposit accounts at $19 million were also relatively flat. We believe that is a likely run rate going forward.

Regarding Durbin we expect the fourth quarter impact will be about $4 million, and we anticipate the annualized gross revenue impact from the final decision will be $17 million to $19 million. Like other banks we are exploring ways to mitigate the impact of these regulatory changes.

Second quarter trust fees were $10 million, up 2% from last quarter. We are making great progress on several initiatives, including program and product enhancements aimed at driving organic growth in the wealth business, in addition we are beginning to see better collaboration between our commercial bankers and our private bankers, as we continue our work to enhance the flow of referrals between the two areas.

As pointed out in the release, fee income was impacted by a $6 million reduction in the value of mortgage servicing rights, primarily due to declining mortgage rates during the quarter, and a $4 million valuation expense related to credit exposure on customer interest rate swap transactions.

Total non-interest expense for the quarter was down $5 million, or 3%. Personnel expense was consistent with what we saw in the first quarter, and a $3 million increase in foreclosure and OREO costs was offset by decreases in other expense categories, including a $3 million seasonal decline in occupancy expense, and lower expenses for unfunded commitments and litigation reserves.

Moving on to credit, non-accrual loans of $468 million declined to the lowest level we have seen in six quarters. That was with no bulk loan sales during the past two quarters. Slide nine shows the significant improvement in our key credit metrics. The ratio of non-accrual loans to total loans continued to improve to 357 basis points from 386 at the end of the first quarter. Our overall level of reserves remained strong at 3.25% of total loans at June 30th, and with coverage of non-accrual loans at 91%.

On slide ten, potential problem loans dropped to $699 million during the quarter. This is a $213 million, or 23% decline from $912 million last quarter. An increasing number of loans migrated off our problem loan list, and the inflow of new problem loans slowed dramatically.

Our loans 30 to 89 days past due remain below 1%, and on slide 12 the key drivers of the provision expense this quarter were net charge-offs of $45 million. The accruing TDR allocation increased $2 million due to higher balances, we released $9 million of FAS-114 reserves on non-accrual loans, and an additional $22 million in reserves related to a decrease in the FAS-5 allocation due to the positive asset quality migration within the portfolio.

We expect provisioning will continue to decline and net charge-offs will remain at around these levels throughout the balance of 2011. We are very encouraged by the overall improvement in credit, which we believe is an indication that things are improving for our customers.

Our capital ratios are on slide 13, and they remain very strong, well in excess of regulatory benchmarks, and what will be expected under Basel 3. Now you may have seen some local press coverage about another one of our initiatives, our branch and signage upgrades. We are about six months into our four-year effort to upgrade and strategically invest in our branches around our footprint. Eleven branch remodels are currently underway or on schedule, 48 additional remodels are in various stages of planning and design. Installation of new signage in the St. Louis and central Illinois markets is complete, and we are on track for completion in Milwaukee and other parts of Wisconsin by the end of the year.

Renovation of the branch in our very first location, Neenah, Wisconsin, is in process as we prepare for Associated Bank's 150th anniversary later this fall.

Finally we are pleased to announce that Jay Williams has joined our Board of Directors. He brings a wealth of banking experience to the Board, with 37 years of commercial banking experience in our markets. Jay lives in Milwaukee, and he is very active in the community.

With that, I would like to open it up to your questions.

(Operator Instructions). Our first question is from Jon Arfstrom, RBC Capital, your line is open.

Thank you, good afternoon.

Hi, John.

Congratulations on Jay joining your Board, I think that should be a big help in Milwaukee. Just a question on Milwaukee specifically. You talked about the 80 new hires. Is that expense in the run rate, or how do we think about that rolling through expenses.

It is largely in the run rate. We have been hiring people pretty consistently throughout the last six months. It hasn't been a big rush at the end of the quarter. I would say most of those expenses you have seen in the first and second quarter, and you can see our personnel expenses have been pretty flat. Although we are adding these folks, other people are leaving in other places.

Is it safe to say there is more to come in Milwaukee, or do you feel like you are essentially there, in terms of who you need?

We are not just in Milwaukee, but across the footprint eager and anxious to hire folks who can help us grow the Company, and we continue to do that.

Okay, and then just on the C&I growth you talked a little bit about where you are seeing some of the growth geographically, but curious if you could comment on market share gains versus new relationships. And on the new relationships if there is a common theme?

It is really hard to do that because it is all anecdotal, Jon. We have had a little bit of line pickup which is probably indicative of lift in the market, lift from the economic activity. The bulk of what we are doing is, typically in the commercial side, in the regions taking some share from someone else, but it is pretty early days to try to equate that to some kind of market share gain. But we are happy with more than $400 million of net outstanding loan growth. And we are reasonably optimistic about the rest of the year.

Whether it is a combination of picking up market share, economic recovery, or the entry into some new businesses through the specialized financial services area, our momentum is really starting to pick up.

Okay, and then just one real detailed question, is there any story behind the foreclosure expense? I know you have that every quarter but it was a little higher than I thought it would be?

Not that I am aware of. I know that we had a, I recall that we had a sizable property tax issue that we had to pay, but there wasn't anything particularly exciting there.

Alright, thanks for the help.

Thank you, our next question is from Emlen Harmon of Jefferies, your line is open.

Hello, good evening, could you talk about the disposal plan for NPAs at this point. I know you guys had halted the bulk sales the past couple of quarters. Could you give us sense on just how you plan to work things down going forward?

That is a great question. We obviously had a concerted sales effort throughout the latter part of last year where we dramatically reduced the NPAs. The NPAs that we have left we are working the old fashioned way, if you will. So we are not indulging in bulk loan sales anymore because we really don't need to. We had a reasonable amount of NPA reduction this quarter. We expect probably some acceleration in that through the rest of the year. We have a couple of sizable non-performing loans which we think will reach resolution this quarter or next.

The truth is most of the big NPAs are gone, and what you see left is pretty granular. So it doesn't really lend itself to the bulk sales that we did previously. So we will continue to work on that. Scott Hickey and I were talking just today about thinking through plans to reduce some of these smaller NPAs as we get through the year. But with the economic recovery that we are seeing here in the Midwest, a lot of these companies are getting healthier without any extraordinary effort on our part.

Got it. Okay, thanks. And then the second question could you maybe give us a little bit more color just on where you are with the specialty lending initiatives, and just what the progress on growth there has been?

Sure, so about half of our net C&I growth came from the specialty units. We had Joe help me, it was about $80 million of growth in the mortgage banking business. We had about $60 million or so in the oil and gas space, and the rest was scattered around some of the other units. We are starting to get nice lift from these new businesses that we put in place over the last six to nine months.

Okay, great, thank you for taking my questions.

Sure.

Thank you, our next question is from Tony Davis, Stifel Nicolaus, your line is open.

Good afternoon, Phil, Joe. Just on that same vein, are you now fully staffed in specialized, and any thoughts on where that portfolio in terms of size may end the year?

We are still looking for a few folks, but we are largely staffed in those areas. I think on the last call or somewhere publicly we had talked about trying to grow that portfolio to around $1 billion or so. We didn't think we were --. In commitments. In commitments, yes, not outstandings. So we put on a net new $120 million this quarter. If we could do the same over the next couple of quarters in each quarter that would be great, and that would probably put our outstandings at $0.75 billion, give or take.

Right.

Phil, continuing in C&I. What you are seeing, maybe Scott has comments on this too, what you are seeing in terms of recent credit spreads, price competition, and I guess too, across loan sizes, and if there is any geographic dispersion around what you are seeing in terms of competition?

Yes, again it's anecdotal. Clearly yields on new loans are coming down, because it is competitive. I would say it is probably most competitive in the market that you would guess would be most competitive in, which is Chicago. We continue to be pleased that a lot of our renewals are able to retain their floors, but clearly the new business that we are out competing for doesn't have rarely are we going to get a floor baked into that new transaction.

Yes.

So yields are coming down on the new stuff due to competition. On the other hand, as I said, we intend on being very price competitive. We have a very attractive overall cost of funds at this Company. And if we are doing our job cross-selling our other products and services, it is always worth it to be competitive on the pricing of a commercial loan.

Yes. Joe, what are you doing, is it roughly $145 million, I guess, insecurities cash flows. I noticed the residential mortgage book is continuing to grow. What are your thoughts here, I guess at this point and where are you channeling that?

We are seeing somewhere in the neighborhood of $300 million to $350 million a quarter of cash flow coming off of the investment portfolio. We are reinvesting about $150 million of it, and using the rest of it to grow loans. That has been our strategy. Clearly the investment yields are low. They are in the 2% range. We are trying to be in the market steadily, but it is really not a very attractive place to be at this point.

Yes. How much of the, I guess your thoughts heading into the Reg Q environment here, guys, about pricing and what are your expectations on your market?

We will see what other banks start doing. We don't really have any news on that yet. However, we believe as we have been saying consistently, that given that the vast bulk of our commercial borrowers are already on analysis, we don't think this is going to be a particularly noticeable impact if we do start paying interest to, say small businesses, or the odd commercial account that might not be analyzed today.

Okay, okay, good, thank you very much.

Thank you, our next question is from David George of Baird, your line is open.

Thank you for taking the question. Question on capital, obviously job one as you think Phil about deploying excess capital over time, given the fact that you have been profitable for a few quarters now. When you think more intermediate to longer term is there a Tier 1 common kind of Basel 3 number that you think about that is reasonable in managing the Company in the future? Thanks.

I know the whole world would love to hear the answer to that question, not just from us but from every bank. I don't know have a great answer for you right now. We are focused right now on growing the Company organically and utilizing our capital to support of that growth. We are focused on repaying the balance of our TARP money in the third or fourth quarter. After that we are with continued profitability and we now have a solid year of profitability behind us. We will take a look at our dividend policy later this year, and then ultimately we will look at deploying capital through acquisitions and even way out there, and probably now preferentially through share buy backs. So where that all ends up, and where the industry ends up, and what a reasonable return on equity is going to be, is still to be determined in the industry.

True. Thanks for the color. Appreciate it.

Thank you, our next question is from Scott Siefers, Sandler O'Neill, your line is open.

Good afternoon, guys, I guess my first question is on the overall expense outlook. This quarter's number came in better than I thought it would. You were talking about continuing to be eager to hire more people. I am just curious to hear how that all flushes into the cost side?

We maintain cost discipline around this place. We have been doing well the first couple of quarters. We have a number of investments that we are making in the Company. The branch remodel that I talked about, some systems upgrades for internal measurement, as well as looking to hire folks. The people we are hiring we view as further investment in growing the profitability of the Company. They will pay for themselves, as will all of these things, but it will take some time. So I wouldn't expect to see dramatic expense growth through the balance of this year.

Okay. And then separately I was hoping you could talk a little bit about what the strategy is, or what is going on with the core deposit base? I appreciated the color on the total face and some of the areas you are trying to push some money out, but the core deposit base at least as I would define it, hasn't grown very robustly, and in fact, has been declining for a few of the last couple of quarters. I know you had the tag issue last quarter, but what are the main dynamics at play there?

The way we view our core funding from customers is it is not declining, it is growing. We made some purposeful decisions which I know are somewhat different from what others in the industry have done, to utilize the collateral we have with the expiration of the tag program, to push some of our customer funding into repos. We are very focused on pushing network and brokered, i.e. non-core deposits out. We have been doing that very consistently now for quarters. We are also very focused on growing the regular core deposits of the Company, and we continue to work hard to do that.

We are investing a significant amount of time, energy, money, and people into improving our Treasury management offerings to grow our commercial deposit base. The outcome of that will be felt in coming quarters. We haven't seen that yet. So we are real focused on growing customer deposits.

And then last question, so, pretty much all the credit metrics are moving in the right direction, but the one that is kind of still going the other way is the accrued and restructured, which are going up in double digits pretty consistently. I wondering if you could talk about the strategy there?

Yes, this is Scott. I mean, the accruing TDRs, we are doing less and less really restructurings on the residential side than we probably did in the last six months. So that piece of it is probably going to level off. The new accounting that comes in the second half of the year we are looking at all of the TDR book as well relative to the new accounting. So we will have to see how that all sorts out as we get through the whole book.

But Scott the other thing that is impacting is you are doing AB notes, which affect TDRs also.

Yes, but we are not doing nearly as many of those as we thought.

No, but that is affecting some of the growth.

Correct.

If you do one, it is a growth.

Right.

Yet the loan is paying.

Scott, remember that we have a pretty low base of this stuff. So it doesn't take more than a couple of loans for you to see it.

See a percentage change.

Exactly.

Okay, great, thank you very much.

Thank you, our next question is from Erika Penala from Bank of America Merrill Lynch. Your line is open.

Thank you. Good afternoon. My first question is on your loan growth guidance for the second half of the year. Given your commentary with regard to positive economic underpinnings in the upper Midwest, and the hirings and consolidation activity in your footprint that is setting you up for taking market share, I am wondering what you are seeing that loan growth is not going to be at least flat from what you posted in the second quarter?

It is very difficult to forecast loan growth. So we had about 3% first quarter to second quarter. Our best look right now is that pace may come off a little bit. That is why we are guiding to the 2% to 3%. I hope we beat it. I think that is a number that we are comfortable with, and that you could probably be comfortable modeling.

Is it a function of more careful commentary from your customers in terms of expanding their business at this point in the economic cycle, or --?

No, it is not.

Okay. With regards to Durbin, we have gotten commentary from some other regional banks with regards to potential mitigation. I am wondering if it is also like with your commentary on Reg Q, too early to tell in terms of how much you can make up for this?

It is, Erica. We fully intend on figuring out some way to claw back some of this revenue, whether we do it directly on the product, debit cards, or whether we change the way we think about charging for the overall bundle of services, we are still working on. Some of this has to do with what the rest of the entry does, so it is a little early. But probably as we get into later in the third quarter we will have a better feel for that, and we can hopefully give some color.

Okay. Lastly I wanted to follow up on your comments regarding capital management. Are you, in terms of preferring acquisitions over buybacks, are you seriously looking at anything today? Clearly you still have TARP outstanding and repaying that in a shareholder-friendly manner is a priority, but I am just wondering if you are seeing specific opportunities in your footprint?

No, we are not looking at anything today, and repaying TARP of course is the first step. So we are very focused on getting that done, as you said in the most shareholder-friendly way possible. When I was talking about deploying capital, I was thinking further out.

Okay, thank you, Phil.

Sure.

Thank you, (Operator Instructions). Our next question is from Terry McEvoy of Oppenheimer. The line is open.

Good afternoon. Could you talk about the new talent that has been hired? Has any of that been in the private banking area? I know a year-plus ago you talked about that being an initiative and an area of focus, and it seems like there would be good opportunities coming out of Milwaukee?

Yes, and in fact, we have hired some great people in our wealth business in Milwaukee, as well as in some of our other metro centers, including Chicago and Minneapolis.

And Phil, do you think you can keep the share count unchanged as you look at the rest of the TARP repayment in the third and fourth quarter?

I hope so, but we will have to find out.

I understand. Then just the last question. Could you just give us a level of comfort the bank in Green Bay growing $300 million in C&I loans last quarter, $60 million or $80 million coming in oil and gas, kind of some new areas for this Company. Just make us feel a little bit comfortable with the people and the decision making, and how we should feel comfortable with that, call it more rapid asset growth than Associated is used to?

Sure, well, certainly the overall asset growth is not something Associated is not used to. Specifically in the energy business the comfort, of course, doesn't come from the legacy of Associated Bank in the upper Midwest, but I have a deep personal background in that business as do the people that we have hired to oversee the business, and the person who is doing the business is actually in Houston. Green Bay not being a hotbed of energy lending in the United States. So we have experienced people on the ground, all of whom I have worked with, frankly, including on the technical side of that business, for many years in my past. If that helps give you some comfort, I am pretty comfortable with it.

Appreciate it. Thank you.

Sure.

Thank you, ladies and gentlemen. This ends the Q&A portion of today's call. I would like to turn the conference over to the President and CEO, Mr. Philip Flynn.

Okay. I want to thank everybody for joining the call today, and for all of the questions. We continue to make great progress in returning Associated to strength and health. We anticipate continued loan and earnings growth throughout the rest of the year, improving credit metrics, and the repayment of our remaining TARP funds. We look forward to talking to all of you next quarter. If you have any questions in the meantime, as always give us a call. Thanks again for your interest in Associated Bank.

Ladies and gentlemen this concludes the Associated Banc-Corp second quarter 2011 conference call. If you would like to listen to a replay of today's call, please dial 1-800-642-1687. International participants, dial 1-706-645-9291 entering the access code 75804403. The replay will be available until August 21, 2011. Thank you for your participation. You may now disconnect.